Where does the mystery of the Dow averaging 10% a year come from?

Question

The Dow opened in 1896 at $40 and was $1000 in 1972. That is exactly inflation. The Dollar decreased to 1/25 of its 1896 value. That means, until 1972, the Dow merely kept par with inflation.
The original dow comprised of only 12 stocks. Adjusted for that, the picture looks even more desolutionary. If you invested money in the Dow in 1896, you would have in 1972 less money, then you put in.
Only under Clinton, the Dow hauled from 2700 to 10,500 by the end of his tenure (1993 to 2000).
Since Bush (2000) the Dow has not kept up with inflation again, similar like it didn't the first 78 years.
Without the 401's in Mutual Funds, the Dow would most likely be at 3000 today.
My question is, where does the myth come from, that investing in stocks or funds will increase your wealth over the long run?
Or is that a marketing lie to cash in on us stupid sheep?

Answer 1

The price of the Dow does not include dividends. Dividends comprise an enormous amount of the return of the Dow stocks. The usual statement is that more than 40% of your return comes from dividends, though that depends upon the index and the time frame that you are considering. (It's hard to find long-term total returns for the Dow. I tried.)

So, stocks actually did much better than inflation over the period that you are looking at. We aren't sheep. (Baah!)

Answer 2

I can not pin-point you where the idea of averaging 8-10% return (not adjusted for inflation) in the stock market first comes from. I do know from the various books I've read (random walk down wall street, the intelligent investor) that such concept existed since the 70s and are probably backed by objective studies. It should not surprise you that it is a reasonable return because if bonds, can have a return of say 4-6%, then why shouldn't the stocks, which is riskier, carry a slightly greater return? Just to answer your doubt of the stock market between 1892 and 1972. You cannot simply calculate the return of stock by simply measure the points gain, what about the dividends? And back in those times, dividends accounts for a significant part of the total return. (although i am still surprised that the point gain between the era only managed to keep up with inflation). As for the great bull market of the 90s, it became a bubble at the end and went burst. That accounts why the market was so stagnant during most of Bush administration. But then again, 6-7 years are not even considered long term. We are talking about way longer time fram than that. To conclude, high single digit to low double digit is what you can expect from investing, and in most times what you are able to get (even for the professionals, just ask the majority of mutual fund managers who can't even outperform the S&P 500). So, don't worry about getting duped by those claims. (it's a different story if a fund/someone promise your return of >15%, it is just so impossible to outperform the market consistantly over the long run, only a few have done it.)

Answer 3

Your math is a bit off...

According to a handly little website called the inflation calculator $4.86 in 1972 had the purchasing power of $1 in 1896, which is obviously well below the increase in the dow over the same time period.

The dow apparently hit its all time low on 28.48 in 1896. By Dec 31st, 2001 it stood at 10,788 increasing 378.8 times during that period. In 2001 $19.95 had the same purchasing power as $1 in 1896. This is a little less than a 6% compound return, however the market average doesn't include dividend payments. Also the DJIA is a listing of large companies, which tend to grow a bit more slowly than the market as a whole.

Also stocks are not trading at historically abnormal PE ratios (ie there is absolutely no basis behind your 3000 remark.)

Answer 4

First, the inflation rate from 1896 to 1972 was much lower than you think it was. It actually averaged 2.10%, much lower than the average annual return of 4.33% for the Dow. Where do I get my numbers? Well, the inflation calculation came from the inflation calculator at westegg.com and the Dow return is calculated from the numbers you gave.

In other words, you would have made a real return of 2.23% each year from 1986 to 1976. That's pretty good.

The fact that the original Dow contained 12 stocks and the current one has 30 is irrelevent. When stocks are added or changed the divisor is changed to keep a level playing field.

Since you're so wrong and I'm not even half way through your posting I'm not going to bother refuting the rest of it. Do your homework before post a bunch of inaccurate nonsence.

Answer 5

I think that the basis of the Dow Jones average growth rate is based on academic research done on securities returns. Most of the research I have seen on DJIA and S&P500 returns either begins in 1945 post-war era or in 1982 (the beginning of the latest major cycle).

While you're right that the long-term price appreciation since 1900 (to early 2006) is around 5% per year (compounded annual growth rate),

However, the same price appreciation rate is around 7% since 1945. This sort of makes sense since the market was relatively flat in the 1900s to 1920, then also suffered in the Great Depression. If you add to the average price appreciation the annual 2-3% dividend rate that the DJIA stocks have delivered on average in this period, you get a total return of 9-10% (around mythological number you refer to).

Since 1982, the annual growth rate was roughly 11%. The basis of the myth could also be based on this time frame.

I would take a look at research done by Ibbotson & Associates in Chicago for more detail, as well as research from the University of Chicago's Center for Research on Securities Prices (CRSP), as well as the book "Stocks for the Long Run" by Jeremy Seigel at Wharton.

Hope this helps. If your underlying question relates to the merits of stock investing vs bonds, I think the weight of the academic evidence is strongly in favor of a diversified portfolio that includes domestic & international stocks, bonds, etc.

Answer 6

They're both annualized rates. While the rate of 8-10 percent, usually cited as the S and P return, is a nominal rate its still around 7 percent real return, compared to a 3-4 percent annualized rate of inflation.

Answer 7

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Answer 8

Inflation did not average 10% per year. Inflation is currently only 2-3% (not counting gas), and my stocks are doing very well this year (not counting the last month).