It is amazing that we all spend so much time talking about "the market". That's fine for those who have their money buried in a managed fund invested in the market, but for the average 10- to 20-stock direct investor or trader, the market and the indices that represent it are almost completely irrelevant. Here's why:
For one, you are not invested in the market, you are invested in specific stocks. That's what the sharemarket is all about - which stocks you hold and what they are doing. That's what will determine your return and that is where you should focus your attention. Not the whole market. Why look at it?
Amazingly, 50 per cent of the Australian market index is represented by the 20 biggest stocks, and 80 per cent by just 50 stocks. The index is hardly representative of all 1900 stocks. If you are not invested in BHP, the big four banks, Telstra, Wesfarmers, Woolworths, Rio Tinto or Woodside, 50 per cent of the index calculation is irrelevant to you.
The market is dominated by three almost entirely independent sectors - financials, resources and industrials. Mixing them all together in one index quote doesn't tell you much. You have to look at them individually to know what's going on and to make decisions on stock trends. For instance, although most people think the market peaked in November 2007, the truth is that the resources sector didn't peak for another six months. If you had made a decision on all your stocks based on your assessment of the market, you would have missed the fact that the resources were still going up while the financials were going into a subprime spiral.
The index is a tool used by big institutions to generate average market returns, which are then used in financial product marketing as a basis for quoting expected future returns. But the truth is that the average market returns of the past bear absolutely no relation to how the market will perform in the future. The average return from the All Ordinaries Index over the past 75 years works out to 5.76 per cent but, laughably, no one-year period has actually returned 5.76 per cent, and the dispersion of returns is enormous, with the highest return at 86.1 per cent and the lowest at a negative 41.7 per cent. In the next one, five, 10 or 20 years, you are going to experience your own unique set of returns and they will bear no relation to the 5.76 per cent return over the very long term. Average returns are a marketing tool, a lie designed to make you feel comfortable so you will buy something, and anyone citing past returns as a justification for making future investments is either ignorant, lazy or selling you something. Past returns as a guide to the future, especially in the current turmoil, is the elephant in the room when it comes to sharemarket lies. They are irrelevant at best and a deception at worst. When a product says past performance is no guarantee of future returns, it's not a disclaimer, it's a fact.
Even if the index returns do recur in the future, you are not going to make money out of the market. That's because 5.76 per cent, less inflation, is not much. The government says inflation is between 2 per cent and 3 per cent but the long-term average is more like 4.7 per cent, and the truth is that we all have our own unique inflation rate depending on what we spend our money on. If you eat, drive, pay school fees or eat bananas, it's higher than 4.7 per cent. Headline inflation is politics, not statistics. Even if you deduct the current inflation rate of 3.6 per cent, it means you are dealing with a historic average real return from the market of 2.16 per cent. And then there are dealing costs, taxes, management fees if you are in a managed fund, and financial planner fees and the associated product trail commissions if you used a planner to buy your managed fund. If it wasn't for dividends, which most people don't compound and retirees almost certainly spend, there wouldn't be much point investing for the average return. Basically you have to do better and that means being in the right stocks at the right time, not all of the time.
The market is the tool of commentators, the media, product sellers and fund managers who use it as a benchmark. But you have no benchmark. It is far better for you to forget the market and deal with stocks - the stocks that you hold. That's the game.
Frequently Asked Questions about this Article…
As a direct investor in 10–20 stocks, should I watch the overall market index (All Ordinaries)?
Probably not — if you hold a small portfolio of individual stocks you are invested in those companies, not the market index. The article explains that indices are built from a small number of large stocks and don’t reflect what most individual holdings are doing, so your attention is better spent on the specific stocks you own and their fundamentals and trends.
How concentrated is the Australian market index and why does that matter for my investments?
Very concentrated: about 50% of the Australian index is represented by the 20 biggest stocks, and roughly 80% by the top 50. That means the index is heavily skewed toward a handful of large companies (for example BHP, the big four banks, Telstra, Wesfarmers, Woolworths, Rio Tinto and Woodside), so its moves won’t reflect the performance of the roughly 1,900 other listed stocks.
Why can following 'the market' be misleading when deciding to buy or sell specific stocks?
Because the market index mixes very different sectors together. The article highlights that financials, resources and industrials largely move independently. An index quote can mask important sector differences — for instance in 2007 resources kept rising while financials were already in trouble — so acting only on an index view can lead you to miss stock- or sector-specific opportunities or risks.
Are long-term average index returns (like the All Ordinaries 5.76%) a reliable guide to future returns?
No — long-term averages are poor predictors of short- and medium-term outcomes. The article notes the All Ordinaries’ 75‑year average is 5.76%, but annual returns have varied hugely (from +86.1% to −41.7%) and no one-year period returned exactly 5.76%. Average returns are often used as a marketing figure and don’t guarantee future performance.
How do inflation, fees and taxes affect the real return I’ll get from the market?
They reduce it significantly. The piece points out long-term headline inflation is closer to 4.7% (current cited at 3.6%), so a 5.76% nominal market return becomes a low real return after inflation — the article gives an example real return of about 2.16% after deducting 3.6%. On top of that you still face dealing costs, taxes, management fees and adviser commissions, all of which cut into net returns.
Should everyday investors rely on dividends when investing in shares?
Yes — dividends are important. The article argues that without dividends there isn’t much point for average investors chasing the average market return, because dividends substantially contribute to overall returns. It also notes many investors don’t compound dividends and retirees often rely on spending them.
If I don’t use the market index as my benchmark, what should I focus on instead?
Focus on the stocks you hold: their business fundamentals, sector trends, entry and exit timing, and whether you’re in the right stocks at the right time. The article’s main message is to 'forget the market' as a personal benchmark and concentrate on individual stock performance and company-specific research.
Why are product sellers and fund managers keen to quote market averages, and how should I view those claims?
Institutions use market indices as a benchmark to generate and market average returns. The article warns that past returns are often used to make products look attractive, but past performance is not a reliable predictor of future results. Treat such claims cautiously — past averages are a marketing tool and not a guarantee of what you’ll earn.
Call 1300 880 160
Start a chat
Schedule a call
