Terry Savage: Which stock market? It matters when judging returns

Last week’s column explained why it’s so difficult to “beat” the market. A review of professional money managers by S&P Dow Jones Indices revealed that half of large cap fund managers failed to beat their benchmark index (typically the S&P 500) in 2022.

And even those who outperform do so on a temporary basis; only 5% of the above-median large-cap active equity funds in calendar year 2020 remained above median in each of the two succeeding years.


If the pros can’t consistently beat the market, why should you try? Or more importantly, why should you pay management fees and commissions, when you could just invest in the index?

The point of that column was to encourage long-term investing, which has proved a winning strategy over time. I used the S&P 500 stock index to define “the market” since that is the “benchmark” for managers of large company stock portfolios. But most investors watch the changes in the Dow Jones Industrial Average, which includes only 30 companies.


The two indexes are calculated differently. The S&P 500 uses a “weighted average” based on the market value of its components, while the DJIA is a price-weighted index, calculated by taking the sum of the prices of the 30 stocks, then dividing it by the Dow Jones Divisor, which is adjusted based on stock splits and rights offerings, smoothing their impact.

Last week’s column noted that the S&P 500 stock index has risen about 9% so far this year. But a closer look reveals a dramatic discrepancy. Fewer than 20 stocks, mostly tech, have driven 85% of the S&P 500′s gains this year.

In the latest issue of the Investech newsletter, market historian Jim Stack (www.Investech.com) points out:

“A breakdown of sector returns on a year-to-date basis highlights that just 3 of 11 sectors in the S&P 500 Index are contributing the vast majority of the gains. The communications, technology, and consumer discretionary sectors have all produced double-digit returns as Wall Street anticipates an interest rate pause by the Federal Reserve and a corresponding economic rebound.

“More defensive sectors like Consumer Staples, Health Care, Utilities, and even Energy (which tends to do well at the very end of an economic cycle) are all lagging behind the Index by a sizable margin. Three of these historically resilient sectors have actually seen negative returns so far this year.”

His conclusion: “The fact that the S&P 500 Index is overwhelmingly weighted toward a small group of stocks is worrisome. … This dichotomy between speculative winners and defensive losers makes investing safely in this market environment both confusing and highly risky.”

Jim Stack has been prescient in calling both bull and bear turns. And when he advises his subscribers to build cash reserves, I always listen. Currently, his Model Fund Portfolio is 48% invested, with 52% held in short-term Treasurys or a money market fund.

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Your first responsibility is to sort out how much of your own assets to invest in the stock market. Then, there’s a clear case for long-term investing in the “whole” market using an index. But does it matter which index you use — DJIA or S&P 500?


Daniel P. Wiener of AdviserInvestments.com, another great market historian, says the difference between the performance of these two indices can vary substantially, noting: “It’s only the past five-and-a-half months when the S&P has been taking the Dow to the cleaners. So far in 2023, the S&P index is up 9.18% versus 2.20% for the Dow. But go back to the comparable period in 2022; the Dow dropped 13.99% while the S&P was down 18.16%.”

Wiener reminds investors that dividends — over the long run — have created roughly 40% of the gains in the market. And when you factor in the dividends, the Dow is currently doing better than it may appear.

“The Dow is much closer to its record high, set in January 2022 than the S&P. Counting dividends, the Dow is just 6.5% below its January 2022 high while the S&P 500 is 10.6% below its high.”

So next time you refer to the “stock market,” be sure you know which market you’re talking about. And then have the discipline to ride out the ups and downs. Over the long run, that’s the best way to build stock market wealth. And that’s The Savage Truth.

(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)

©2023 Terry Savage. Distributed by Tribune Content Agency, LLC.