The Standard and Poor's 500 Index is the most widely used and commonly cited benchmark in the United States. Investors and professionals use the index to gauge the overall health of the stock market and to measure their investment performance. The problem is that the index is built on incomplete data and paints an inaccurate picture of the market's overall history and trajectory.
The S&P 500: Painting a Pretty Picture
When viewed as a chart over the long-term, the S&P 500 reveals a smooth, attractive, upward slope that steadily climbs and gains over time. It is the backbone of the buy-and-hold philosophy, which dominates the culture of the financial industry.
When investors suggest selling their way out of danger, their advisors point to the S&P 500, which reveals that since 1926, the market has always climbed and investors have always gained — as long as they held onto their investments through times of turbulence. Investors are told that the S&P, which tracks 500 securities, is more representative of the overall market than the Dow Jones Industrial Average, which tracks just 30.
Deconstructing the History of the S&P 500
The financial industry points to the S&P 500 as nearly a century's worth of proof that the market always climbs. The problem is, the S&P didn't exist in 1926 — or 1936 or 1946. The modern S&P 500 didn't emerge until 1957, when the Standard Statistics 90 and 233 (neither of which tracked 500 securities) merged into one and combined their data sets.
Before 1957, information on the Standard Statistics 90 and 233 didn't publish their data in newspapers or otherwise make it available to the masses. This data was limited to industry manuals and a handful of select universities and libraries.
The nearly 100-year history of the most legitimized index in the world is actually closer to a 50-year history — and it was delegitimized through secrecy.
Dow Jones Industrial Average: A More Legitimate Benchmark
Unlike the S&P, the The Dow Jones Industrial Average has a long, uninterrupted history that paints a clear, accurate picture of the market's history and current health. Published continuously — and publicly — since May 26, 1896, it is the most definitive data set that exists.
The industry, however, avoids relying the Dow Jones for two reasons.
First, the Dow paints a far less pretty picture than the S&P 500. The first 30 years of its history are littered with crashes. When this inconvenient truth is combined with the rosier S&P data, that smooth, upward slope — which financial professionals love to cite — becomes muddled with long, difficult stretches of volatility. This reality makes it far more difficult to convince buy-and-hold investors that everything will be OK as long as they ride out downturns — like the one that may have been triggered in 1999.
The second reason the industry prefers the less-accurate S&P is based on the assumption that 500 stocks are better than 30. The reality, however, is that prior to 1956, the S&P tracked just 90 companies, not 500. In addition, the Dow actually tracked 60 stocks in its early years, not 30. It tracked 30 companies plus 15 utilities and 15 transports, which was a very accurate representation of the overall market in those days.
The S&P 500 is the standard benchmark that the industry uses to measure the health of the market and the performance of their investments. It is not, however, the most accurate or useful. The S&P omits six devastating crashes of 30 percent, 40 percent or more, and another four major corrections greater than 21 percent. The Dow Jones Industrial Average presents a less rosy, but far more accurate, comprehensive and realistic set of data.
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