Why the Original S&P 500 Stocks Outperformed the Updated Index

The original S&P 500 stocks were re-introduced in 1957 as a stock market index to track the value of the 500 largest listed American companies including all sectors.

What would have happened if an investor had bought the original S&P 500 stocks in 1957 and held them passively? And, how does that return compare to investing in the actual S&P 500 which is periodically updated?

At first glance, it seems like the actual S&P 500 would be a better investment. After all, Microsoft, Apple, and Amazon.com didn’t exist in 1957. Doesn’t a high performing stock portfolio need to be refreshed from time-to-time to include modern firms?

Should investors hold the original S&P 500 stocks passively or invest in the continuously updated S&P 500 index? Research by Jeremy Siegel and Jeremy Schwartz delves into this choice by analyzing the performance of the original S&P 500 stocks from 1957 through 2003. Click here to read their research and see a list of the original S&P 500 stocks from 1957.

Their findings are striking: the original S&P 500 stocks, when held passively, outperformed the continuously updated S&P 500 index. This discovery challenges the conventional wisdom of active management and highlights the potential benefits of a long-term, passive investment strategy known as the Coffee Can Approach.

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Why Invest in the Original S&P 500 Stocks?

Long-term Outperformance: The study calculated the returns of all 500 original firms in the S&P 500 and compared them to the returns of the continuously updated index. Contrary to our intuition, the buy-and-hold returns of the original firms surpassed those of the updated S&P 500 index. This out-performance was not just marginal; it was significant and came with lower risk.

Lower Risk: One of the key findings was that the portfolio of the original S&P 500 stocks exhibited lower volatility compared to the updated index. This lower risk profile, coupled with higher returns, makes a compelling case for a buy-and-hold approach.

Sector Performance: The research also showed that the superior performance of the original firms was widespread across various sectors. For instance, the original firms in the energy sector, which included major oil companies like ExxonMobil and Chevron, outperformed the new entrants in the sector. Similarly, sectors like consumer staples and health care also saw the original firms delivering better returns than their newer counterparts.

Impact of Overvaluation and Indexing: The study attributed the under performance of the new firms in the updated S&P 500 index to valuation. New firms often enter the index during periods of high investor expectations. While old firms leave when their valuations are typically low. Market efficiency wins again. When a company leaves the S&P 500, it does so at a low valuation since investors know its business is struggling. While, new companies enter at high valuations as investors know those companies are on the rise. Valuations reflect expectations.

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Selling is Risky: Embracing the Coffee Can Approach

The study underscores the dangers of selling and active management in general. The continuously updated S&P 500 index, which periodically adds and removes firms, under performed the portfolio of original S&P 500 stocks held without change. This finding supports the idea that a buy-and-hold strategy, free from the biases and costs associated with active trading, will lead to superior long-term returns.

Counter-Intuitive Results: The Role of Emotional Bias

The research also highlights how counter-intuitive results can reveal the pitfalls of emotional and cognitive biases in investment decisions. Investors often believe that actively managing their portfolios and incorporating new, promising firms will yield better returns. However, the study found that these new firms typically under performed the original firms. Challenging the notion that active management is superior and underscoring the importance of a disciplined, passive approach.

Avoiding Confirmation Bias: Benefits of Passive Investing

Its crucial for investors to remain open to new information and willing to change their minds when presented with evidence that contradicts their current beliefs. Confirmation bias, or the tendency to seek out information that confirms existing opinions, can lead to poor investment decisions. When presented with research that proves a passive portfolio beats an active one, many investment advisors will dismiss the facts. Because to them, it undermines the perceived value of active management. But, a healthier approach is to accept new information and adapt based on it.

Original S&P 500 Stocks: The Coffee Can Approach

The research by Siegel and Schwartz makes a compelling case for the Coffee Can Approach to investing. Holding the original S&P 500 stocks passively has historically outperformed the continuously updated S&P 500 index, highlighting the dangers of selling and the benefits of a long-term buy-and-hold strategies. These counter-intuitive results underscore the role of emotional bias in investment decisions and the importance of remaining open to new information. Investors are encouraged to embrace the Coffee Can Approach to achieve greater financial success. To learn more about implementing this strategy in your investment portfolio, click here to contact us.

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