IT IS amazing that we all spend so much time talking about "the market".
That's fine for someone who has their money buried in a managed fund invested in "the market" but for the average 10-20 stock direct investor or trader the market and the Australian indices that represent the market are an almost complete irrelevance. Here's why:
For one, you are not invested in "the market" but in 10 to 20 specific stocks. That's what the stockmarket is all about, which stocks you hold and what they are doing. That's what will determine your return and this is where you should focus your attention and efforts. Not "the (whole) market". Why look at that?
Half the market index in Australia 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 four banks, Telstra, Wesfarmers, Woolworths, Rio or Woodside then half the index is irrelevant to you.
The Australian market is dominated by three almost entirely independent sectors: financials, resources and industrials. Mixing them 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 everyone thinks 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 average market returns in the past bear no relation to how the market is going to perform in the future.
The average return from the All Ords over the past 75 years is 5.76 per cent but laughably not one 12-month period has actually returned 5.76 per cent and the dispersion of returns is enormous the highest was 86.1 per cent and the lowest minus 41.7 per cent.
Average returns are a marketing tool, designed to make you feel comfortable so you will buy something. Anyone peddling past returns to justify a future investment 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 stockmarket 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 did repeat in the future you would not make money out of "the market" 5.76 per cent less inflation is not much.
The government says inflation is 2-3 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. But even if you take off the current 3.6 per cent it means you are dealing with a historic average real return from "the market" of 2.16 per cent. And if you then take off dealing costs, tax, management fees if you are in a managed fund, financial planner fees if you used one to buy your managed fund, the associated product trails, and the index fudge, you can see that the market is a lot of fuss about nothing.
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, which means being in the right stocks at the right time not all the time.
"The market" is the tool of commentators, the media, product sellers and the fund managers who use it as a benchmark. But you have no benchmark. Far better then that you forget the market and deal with "stocks" the stocks that you hold. That's the game.
For a free trial go to marcustoday.com.au. His views do not necessarily reflect the views of Patersons.
Frequently Asked Questions about this Article…
What does the phrase “you are not in the market” mean for everyday investors?
It means if you hold a small direct portfolio (for example 10–20 stocks) you are invested in those specific companies — not the broad market index. Your returns depend on which stocks you own and how they perform, so focusing on the individual stocks you hold is more useful than watching a headline market number.
Why are market indexes often irrelevant to direct stock investors?
Australian indexes are heavily concentrated: about half the index is represented by the 20 biggest stocks and 80% by just 50 stocks out of roughly 1,900. If you don’t own those large names (for example BHP, the big banks, Telstra, Wesfarmers, Woolworths, Rio or Woodside), the index can be largely irrelevant to your personal portfolio.
How do sector differences make a single market number misleading?
The Australian market is dominated by three largely independent sectors — financials, resources and industrials — so mixing them into one index hides important trends. For example, resources kept rising for months after financials started falling in 2007; a single index would have masked those sector-specific moves.
Are average market returns a reliable guide to future investment performance?
No — average returns are a historical marketing tool and don’t predict the future. The All Ordinaries’ average over 75 years is quoted as 5.76% but yearly returns vary wildly (the best was +86.1% and the worst −41.7%), so relying on past averages to forecast future results is misleading.
How does inflation and fees affect the real return from market investments?
Inflation and investment costs erode headline market returns. The article notes official inflation targets of 2–3% but a longer-term average nearer 4.7% and a current figure of 3.6%; subtracting that from index returns leaves a very small real return (the piece cites a historic average real return around 2.16%). Add dealing costs, tax, management fees and planner charges and your net return is reduced further.
Why are dividends important for everyday investors and retirees?
Dividends form a large part of total returns for many Australian stocks and are especially important for retirees who spend income rather than compound it. Without dividends, the case for relying on average market returns becomes weaker for investors who need cash flow.
If I shouldn’t focus on “the market,” what should I focus on instead?
Focus on the stocks you actually own: their businesses, sector trends, and whether you’re in the right stocks at the right time. For direct investors there is no useful personal benchmark in a headline index — your decisions should be based on the companies in your portfolio.
Who uses market indexes and why should retail investors be cautious about index-based marketing?
Big institutions and product sellers use indexes as benchmarks to generate and advertise average market returns. Retail investors should be wary because average past returns are often used to make products look appealing, but they don’t guarantee future performance and can hide the real costs and risks involved.
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