The biggest investment story of the past decade is that stocks went nowhere. The S&P 500 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.
S&P 500 Weight, 2000
Return Since 2000
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.
The article The Most Important Investment Chart of the Past Decade originally appeared on Fool.com.
Morgan Housel owns shares of ExxonMobil. The Motley Fool recommends Cisco Systems and Intel and owns shares of Citigroup, ExxonMobil, General Electric, Intel, IBM, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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