The Most Important Investment Chart of the Past Decade

The biggest investment story of the past decade is that stocks went nowhere. The S&P 500  (SNPINDEX: ^GSPC  )  is lower today than it was in 2000. Dividends provided some return, but inflation eroded it out. It has been a dreadful decade for stocks.

But this chart might be the best rebuttal to the "lost decade" argument, and perhaps the most important chart of the past decade:

Source: S&P Capital IQ.

What we're looking at here is:

  • The traditional S&P 500 (blue line).
  • The S&P 500 Equal Weight Index, which owns the same 500 companies as the traditional S&P, but holds them in equal amounts. That's different from the traditional index, which weights companies by market cap, owning more of the largest companies and less of smaller ones.

Unlike the traditional S&P 500, the Equal Weight Index is at an all-time high. It's more than doubled since 2000, providing investors with a solid return.

The reason the two indexes strayed so far apart is simple: Megacap companies were all the rage in 2000, making them some of the most overpriced. And since the traditional S&P 500 weights its components by market cap, it was weighted heavily in the market's most overvalued companies.

Look at the S&P 500's largest holdings in 2000 and their subsequent performance.

Company

S&P 500 Weight, 2000

Return Since 2000

Microsoft

4.9%

(54%)

General Electric

4.1%

(57%)

Cisco

3%

(59%)

Wal-Mart

2.5%

 8%

ExxonMobil

2.3%

109%

Intel

2.2%

(46%)

Lucent

1.9%

(97%)

IBM

1.6%

 68%

Citigroup

1.5%

(90%)

AOL*

1.4%

(76%)

Sources: S&P Capital IQ, ETFDB, author's calculations.
*Used former parent company Time Warner to calculate return.

These 10 companies made up more than a quarter of the S&P 500 in 2000. And with a few exceptions, their performance has been an utter bloodbath ever since.

The Equal Weight Index, however, gave each of these companies a weight of just 0.2%, so colossal losses stemming from the megacap dot-com busts had a much smaller impact.

That fact alone has kept the S&P 500's returns low for the past decade relative to the Equal Weight Index.

So the average stock has actually performed well over the past decade. The S&P 500 has done poorly because a handful of companies were grotesquely overvalued a decade ago, and those companies made up a disproportionate share of the index.

This also goes the other way: In 1999, just two companies, Microsoft and Cisco, accounted for one-fifth of the S&P 500's total return. 

Now, this doesn't mean the Equal Weight Index is necessarily a better index. Today, megacap companies are some of the market's cheapest stocks, so there's a decent chance the traditional S&P 500 will outperform the Equal Weight Index in the coming decade.

The important question is, why does the S&P 500 weight its components by market cap? Last month, I interviewed Robert Arnott, CEO of Research Affiliates and a pioneer of alternative index strategies. He told me, "The S&P 500 was never intended as a strategy; it was intended to measure how the market is performing." In Arnott's view, it makes more sense for indexes to weight companies by their economic footprint -- things like revenue, earnings, and dividends.

He went on, describing the S&P 500's growth since its founding in 1957:

By beating most active managers most of the time ... [the S&P 500] gained tremendous traction, and people didn't look at alternatives.

Just imagine if in 1957 the S&P had said: "Here's an S&P 500 that tracks the market. It's cap-weighted, and by the way, we're doing a sister index, S&P Profits 500, that weights companies by their profits." The latter would have trounced the former, and cap-weighted indexation would never have gained popularity.

So it goes. Just a reminder that what's popular isn't always what's best.


Read/Post Comments (16) | Recommend This Article (70)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 06, 2013, at 8:14 PM, TreyAnas wrote:

    There's a line of thinking among some investors that the classic S&P 500 is a good proxy for the overall market and that beating it requires the kind of stock-picking skills few people have. Nonsense.

    Rewind to 2000 and use a "sensible" asset allocation model to diversify your portfolio. Rebalance, say, annually. You will do (or would have done) quite well without having any stock-picking skill at all - far, far better than the S&P.

    Just to get a sense for what might have happened, compare the S&P 500's performance for the last 12 years to that of VWO (emerging markets ETF), IWO (small cap US growth), IWN (small cap US value), and VNQ (REIT). Throw a bond fund in for good measure. Those slices of the market are sometimes well correlated over short periods, but can diverge greatly over a decade.

    The "lost decade" argument is misleading nonsense.

  • Report this Comment On January 07, 2013, at 11:53 AM, astuber9 wrote:

    Fascinating stuff. It is great that Arnott is pioneering this idea but my guess is that my Fidelity 401k will have other index fund options 20-30 years later when I am much closer to retirement.

  • Report this Comment On January 07, 2013, at 12:19 PM, hbofbyu wrote:

    That's a catchy headline but I think the more important chart can be found here:

    http://www.fool.com/investing/general/2012/11/13/a-simple-wa...

  • Report this Comment On January 07, 2013, at 12:19 PM, OceanJackson wrote:

    Ha. One chart is bad, so let me pick one that suits my own needs.

    Anybody can make their own index that paints a time-period favorably.

    It's bad, but wait, it's actually good!

  • Report this Comment On January 07, 2013, at 12:29 PM, allinallgm wrote:

    Did anyone do studies for equal weighted S&P 500 equities with low PE (< S&P PE) and or Higher than S&P Dividend? Thanks in advance.

  • Report this Comment On January 07, 2013, at 1:31 PM, Darwood11 wrote:

    The only constant is change. At present, about 8 years after most of the votes for President decided that "change" was the better way to go, we are dealing with small, or "chump" change.

    Today, the dividend yield on the S&P 500 is about 2.1%. Just about equal to inflation. Your savings account? Return less than inflation. TIPS? That's a ditto.

    OK, investing with a S&P index may be bad, but DOW index is worse. At least the S&P has a better exposure to companies with international business. That, however, is little to recommend over a past span of about 10 years. However, a more appropriate time span is 30 years. That's consistent with most "set and forget" philosophies for retirement funds. Or perhaps we should all construct our own "Mutual Fund" portfolio of selected stocks and hope for the best?

    "The S&P 500 has done poorly because a handful of companies were grotesquely overvalued a decade ago, and those companies made up a disproportionate share of the index." That may also be true of very recent events. I'll use NFLX as an example.

    With the data provided here and elsewhere, I'd say that this points out a possible flaw in the indexing strategies.

    From my personal experience, which requires doing research and buying stocks in individual companies after that research, that's a better way to go. However, about 66% of my retirement funds are invested in mutual funds of various flavors. That includes stocks and bonds.

    My point? I think my gains since 2006 are entirely attributable to a combination of index investing, individual stocks, and contrarily investing. By "contrary" I mean investing that doesn't necessarily meet the stringent requirements of the pundits. For example, buying XOM, CVX, NOv and another 30 companies back when the financial panic was in full force, and "Mad Money" Cramer was telling everyone on the Today Show to sell everything. Energy wasn't the big issue back in 2008. But it, as is true of many commodities, are essential to our needs.

    My suggestion? Buy companies that make something tangible. Avoid banks and fads. I know, very difficult to do when we are attempting to find the "next big thing" of the "next 10-bagger."

    But what do I know? I'm just a small investor, and at 66 I'm still working for a living. Apparently, I'm doing something wrong.

  • Report this Comment On January 07, 2013, at 2:33 PM, rstruyk wrote:

    Great article. It shows that the investor that digs deeper can outperform the market. We can not accept what the media says as correct. We must do our own research and come to our own conclusions. Who here thinks stocks are still a good investment? Who here thinks that the right companies will outperform the market? I do.

  • Report this Comment On January 07, 2013, at 3:52 PM, AnsgarJohn wrote:

    Actually pretty much any logical, fundamental system used consistently seems to beat the S&P in the long run.

    Check out Guru screen results at www.validea.com

    The key is having the stomach not too pull out at the stupidest moment.

    Today I also tabulated the recent results of the "Superinvestors" Sequoia, Tweedy and Buffett, as well as Validea's Benjamin Graham screen and Spain's Bestinver.; www.vlnvst.com

  • Report this Comment On January 07, 2013, at 4:23 PM, brigidl wrote:

    Beating the index is often no great achievement. The index is made up of all sorts of dogs. As an investor we can cherry pick the high achievers with work and savvy, here are my 5 golden rules.

    1 work hard at research

    2 read everything you can but remember that the writer may have an agenda other than accuracy and truth.

    3 avoid stocks that are fads fashion and hype. Think peter lynch... low key, boring, unloved, small... and ideally with a dividend.

    4 find value, buy cheap. Can you visualize this stock at double the price right now? If its not cheap its hard to make money on it.

    5 remember that you are in this game to make money, not to hold shares in cool companies.

  • Report this Comment On January 07, 2013, at 6:11 PM, crca99 wrote:

    So I'm the owner of the lower blue line for about the same amount of time? Wonderful. Another way to lose money.

    The office retirement has limited choices. Upside is contributions are paid in pre-tax dollars and the SP500 index choice has lowest fees. Perhaps I should have paid the tax and invested in different model.

  • Report this Comment On January 08, 2013, at 1:22 AM, TerryHogan wrote:

    @tmfhousel

    I think the idea of a profit-weighted index is pretty intriguing.

    Does anyone know of any out there?

    Thanks.

  • Report this Comment On January 08, 2013, at 9:22 AM, xetn wrote:

    I see Morgan keeps deleting my comments. Typical! I doubt he will allow this one either:

    http://www.caseyresearch.com/gsd/sites/default/files/CPI.png

    He simply cannot allow any opposition to his "genius".

  • Report this Comment On January 08, 2013, at 9:24 AM, TMFMorgan wrote:

    ^ I don't (and can't) delete comments. Sometimes our spam filter will wrongly identify whatever links you're posting as harmful.

  • Report this Comment On January 08, 2013, at 10:25 AM, miteycasey wrote:

    Seriously?

    People are complaining that they 'lost' money by investing an S&P500 index fund?

    The entire point is that an index fund is 'easy'.

    And remember...you get what you pay for.

  • Report this Comment On January 11, 2013, at 7:13 PM, SkepikI wrote:

    This is a good food for thought article Morgan, but I have to agree with hbofbyu that your charts from the November article is much more useful and interesting. Because its up to your usually good standards of getting me to think, I wont complain about its shortcomings. I do have one question and one comment- I am unaware (because I've never bothered to look) of an EVEN WEIGHTED S&P 500 fund or something a close proxy to it... This would be an actionable bit of info...

    I also think there is more at work here than a simple fad for big capital companies "overvalued a decade ago" I don't agree that explains the entirety of their under performance or drag on the index, but cant prove it. It may be more fundamental that the large overly well funded enterprises that make up the Index are devilishly difficult to manage well, and only a handful of the "management teams" that attempt to do so can actually perform this feat. I would suggest to you that the basics of the sets you created here proves larger enterprises invite what I like to call the DIS-ECONOMIES of scale. Bad capital allocation, massive blunders, incentives to bad leaders going the wrong way, or actively creating crooked arrangements and bad accounting...all rampant at large capital intensive companies residing in the S&P 500 that had enough $ and inertia to survive for several years...Enron comes to mind, but its only the most infamous. Less well capitalized residents of the index either found it fatal, or so potentially fatal that they fixed it or avoided it to start with. Anyway that's my theory and I'm sticking to it!

  • Report this Comment On January 17, 2013, at 6:18 PM, aleax wrote:

    @Skepikl, RSP is an equal-weighted S&P 500 ETF, for example.

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