What was the inflation-adjusted annual return for the DOW for the 80 years through September 2008 (price only–no dividends)?
And that’s before capital gains taxes on the nominal (pre-inflation-adjusted) gains. Once you pay those, you’re pretty much at zero.
Thank goodness for dividends, which contributed another 4 points or so.* Of course you had to pay tax on those, too.
Kind of a far cry from the “10% a year” that many financial advisors talk about, no? And that’s before their fees, by the way. Pay those, and you’re doing well not to lose money.
Who do we have to thank for this reminder that stock returns are rarely as good as they sound? John Mauldin and Rob Arnott. Here’s an excerpt from John’s latest letter, which you can sign up for here. He’s referring to the chart above.
So, looking at the lines from the bottom and going up. First, let’s see how you would have done on an inflation-adjusted basis with just the actual Dow 30. It’s not pretty. The price-only inflation-adjusted index returns for the last 80 years are only a mediocre 1.4%! The price level of the Dow 30 is currently less than twice that of its August 1929 peak, net of inflation. Sadly, we last saw the 1929 peak level as recently as October of 1992. That means that an investor in the Dow 30, in August 1929, would have pocketed only the dividends, with no real price appreciation, for some 63 years.
Rob [Arnott] couldn’t resist writing Jeremy [Siegel, author of Stocks For The Long Run], “Net of taxes on the dividends and cap gains taxation on the inflation “gains,” the real after-tax return would have been awfully skinny. Jeremy, I hope you’ll forgive me for saying so, but that’s a ‘Long Run’ indeed!”
What are the rest of those lines?
We’ll discuss them in the next post, but here’s John’s explanation:
The next line is the Dow 30 price-only index (without dividends). That gives us a 4.6% annual average return. The next line up is the Dow 30 total returns, including dividends, which is 8.9%; this shows how important dividends are to the total return of the Dow. And with dividends now fairly skinny and being cut almost monthly by some component or other, we are left to wonder what total return will be over the next few years.
Next, we find that the S&P 500 cap-weighted index outperforms the Dow by about 0.2% annually, for a total return of 9.1%. Not much difference there.
Now we come to the interesting part. The next-to-the-top line is the original Dow 30, using a price-weighted index, just like the current Dow 30 uses. The only changes in the next 80 years are companies getting bought or dying. That “Original 30” gives us an annual return of 9.6%. Just 0.7% a year, so you might think, not much difference. But if you start with $100 and compound it for 80 years, that 0.7% becomes a quite large differential. With the Dow 30, your $100 would have grown to $96,993 as of December 2008, but the Original 30 would have grown to $161,603.
And there is an even bigger differential if you simply equal-weight the components rather than use a price-weighting methodology. Your $100 grows at a 10.4% clip and becomes $272,554, or almost three times the actual Dow 30. This is probably due to the fact that, whenever a change was necessary, it would be natural to add one of the more popular and respected large-cap growth stocks that wasn’t already on the list. It’s hard to earn a “risk premium” on assets that are not seen as having much risk!
What accounts for the difference? There were 34 changes in Dow components in the first five years. Many were dropped and then added back in. It was a VERY fluid index. There were two changes in 1939. IBM was dropped for AT&T, and Nash Kelvinator was again dropped for United Technologies. (NK was dropped the first time in 1930, only to be added back in 1932.) But, most of our Original 30 survived the Depression, so the Original 30 was largely unchanged during those tumultuous years.
*In the original version of this post, I applied the inflation adjustment to the dividend stream, too. A sharp reader observed that this is incorrect.
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