For the last 100 years, we’ve tracked the movement of stocks using the various indices such as the Dow Jones Industrial Average, the S&P 500, etc. In a single number it gives us a general idea of the popularity of stocks overall. But the indices also lie to us a bit.
Today General Motors and Citigroup are going to be dropped from the Dow and replaced with Cisco Systems and Travelers Co. GM is in bankruptcy as of today. Citigroup is still struggling with the nasty real estate loans on their portfolio. So Dow Jones & Co. throw them out and replace them with stronger companies. That means that when you look at the Dow 30, you’re not looking at the same stocks over time. They throw out the weak ones and replace them with stronger ones.
This is one of the reasons that it’s hard to beat the averages, because the averages ‘cheat’. If you could throw out your worst stocks every so often and not count them in your overall returns, you’d look better. This changing of the guards is called survivor bias. The indices look better than they really are, because they will pull out the bankrupt and really weak stocks. The survivors are by definition the stronger stocks. This is especially pronounced in the DJIA which consists of only 30 stocks.
So if you underperform the averages a bit, keep in mind that it’s partly because they cheat and keep the strong survivors over time.