The Clinton Herald, Clinton, Iowa

Local News

May 4, 2013

Stocks come and go so beware of indexes

(Continued)

Meanwhile, much has been written about the market being back to old highs and making new ones. But there is more to that story than meets the eye. Maybe the index is back, but not all stocks. Specifically, have the portfolios of buy and hold investors even come close to coming back?

The market has finally rallied back to the levels of its previous peaks of 2000 and 2007. That allows Wall Street to revive its longtime mantra in support of “buy & hold” investing as a viable strategy and that “the market always comes back.” The claim is based on the fact that the market indexes eventually come back, although it sometimes takes 15 to 20 years, as in the 1930s and 1970s. But does that mean buy and hold investors’ portfolios have come back?

Not at all. The stocks that make up the indexes are periodically changed so significantly as to make the market that comes back entirely different than the market that went away.

For instance, 23 percent of the stocks that were in the Dow in 1999 were no longer in that index just five years later. They had been replaced by stronger companies that were more representative of the changing economy.

Don’t get me wrong. This is necessary. The indexes were developed to closely represent the U.S. economy at any given time. Previously dominant companies that lose their importance in the economy are replaced by the newly dominant companies. So a Sears is replaced by a Home Depot, a Kodak by Pfizer, and so on.

In just the seven years from 1999 and 2006 there were 109 changes in the stocks that comprise the Nasdaq 100, an index that only contains 100 stocks

Obviously, the fact that the indexes come back has little relevance as to whether the stocks buy and hold investors need to come back have done so. You have to wonder which popular stocks currently in the indexes won’t be there the next time the market declines and investors wait for them to come back.

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