Here’s why you shouldn’t base your investment decisions on the daily stock reports

For many people, their sense of how investments are performing comes from 30-second blitzes of radio or television news (or a quick glance at a phone app) that share the day’s return for the Dow and the S&P 500 – two different subsets of U.S. stocks.

Those data nuggets have almost no relevance to how you should think about the performance of your investment portfolio.

It could be helpful to have a comparative benchmark to understand how your strategy has performed relative to the available global marketplace of investments. However, the only true measure of your investment performance should be whether your strategy is supporting your broader financial plans. Are your investments positioned in a way that provides a reasonable probability that you will have enough assets and income to cover your life-long expenses?

Most people don’t need their portfolio to outperform any commonly reported index to achieve financial security. However, the index results are widely reported, so they draw attention. That is the case even when people typically do not know much about the index that they must “beat” to “win” the investing game.

Consider a few examples of why indexes might be less relevant than you expect:

The most recognizable stock market index is the Dow Jones Industrial Average. The “Dow” is reported as a proxy for the U.S. stock market even though it tracks only 30 stocks. The included companies represent a cross-section of industry leaders. Dow members are selected by a committee. In 1939, the committee decided to remove IBM and replace it with AT&T. IBM was added back to the Dow in 1979. Due to the methodology of how the Dow is calculated, emphasizing a stock’s price, the 40-year difference between IBM’s performance and AT&T’s left the Dow 22,000 points less than it would have been if IBM had not been replaced. The Dow’s value inched close to 40,000 at the end of March 2024. With the change of one company in the index, the value of the index could have been more than 50 percent higher than it is today. That doesn’t seem like a methodology that provides any useful measure of how an investment strategy is doing.

The S&P 500 has moderately more relevance. It at least includes a broader representation of U.S. stocks by including a diverse set of 500 companies. Most people assume it is the largest 500 companies in the United States. Instead, there is subjective input as to what companies are included. At the end of March 2024, the S&P 500 included 430 of the largest 500 companies in the United States, measured by their stock market value. The missing 70 companies represented over $2 trillion in market value. That’s a large gap between investor perception of what an index represents and reality.

Just like the missing IBM return that held back the Dow, there’s a more recent example in the S&P 500 Index. Lululemon grew to a market weight that put it well within the largest 500 companies in the U.S. stock market in April 2018. The stock had a choppy, but generally upward, performance trajectory for more than five more years before it was finally added to the S&P 500 in October 2023 when it was the 153rd largest company in the U.S. stock market. Lululemon’s stock price had more than quadrupled in the 65 months between when it entered the largest 500 and when it was added to the S&P 500 Index.

More and more frequently, indexes are looked at not only as representations of markets for comparison’s sake, but as investment vehicles themselves. That also leads to some unexpected differences.

The Russell 2000 Index is considered a measure of small-cap company U.S. stocks. It includes the smallest 2,000 companies in the Russell 3000 index, which is a benchmark for the whole U.S. stock market. The Russell 2000 is not the only measure of small company stocks, however. You could choose to own an index fund based on the Russell 2000 and realize underwhelming performance compared to another small company index. For instance, the Vanguard Small-Cap Index Fund (which can be purchased as an exchange-traded fund using ticker VB) – over the period from its inception Jan. 30, 2004 through April 30, 2024 – generated nearly 100 percentage points more cumulative gain (336.3 percent vs. 238.9 percent) than the iShares Russell 2000 Index ETF (IWM). Both represent small-cap U.S. stocks, but with different methodology for which companies are included.

There are many more idiosyncrasies in indexes and no one index should be used to evaluate a broadly diversified portfolio of U.S. and international stocks and bonds. So, rather than emphasizing indexes as a measure of how your investments are doing, find a way to measure your progress toward lifetime financial security. That’s the only measure that would affect your personal finances anyway.