Many ISA investors prefer to keep things simple when investing for the long term and choose to simply invest their capital in exchange-traded funds (ETFs) that track the UK’s main stock market index – the FTSE 100. Is this a good strategy? Are there better alternatives? Let’s take a look at the pros and cons of owning the FTSE 100 index.
Advantages
The FTSE 100 is a share index of the 100 largest companies listed on the London Stock Exchange. That means that if you own an ETF that tracks the index, such as the iShares Core FTSE 100 UCITS ETF, you’ll have exposure to some of the largest companies in the world, such as Royal Dutch Shell, HSBC Holdings, Unilever and many other household names. From a wealth-building perspective, exposure to these kinds of companies is sensible, as many of the largest stocks in the UK have provided strong long-term returns to investors. Just look at the portfolios of ISA millionaires – there’s a clear focus on large-cap FTSE 100 companies.
Another advantage of the FTSE 100 index is that it has quite a high dividend yield, relative to other indices, as many companies within the index reward their shareholders with big dividends on a regular basis. The current distribution yield on the iShares Core FTSE 100 UCITS ETF is 4.3%. In contrast, the distribution yield on the iShares Core S&P 500 index (which tracks the main US index) is just 1.73%. Dividends make a big difference to your total investment returns over time, so shouldn’t be ignored.
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Disadvantages
However, the FTSE 100 index does have its limitations. For starters, the index is quite concentrated, both in the number of holdings and the exposure to certain sectors. Compared to the S&P 500, which tracks the largest 500 stocks listed on the New York Stock Exchange, the FTSE 100 is less diversified. Furthermore, the FTSE 100 has a large weighting to both the financial and oil sectors and very little exposure to sectors such as technology.
Second, the long-term performance of the FTSE 100 has not been fantastic. For example, for the five-year period to the end of February, the index returned just 37.4% or an annualised return of 6.6%. This is well below the 8%-10% that experts often advise shares will generate over the long term.
So, are there better options out there?
Higher growth
For those seeking diversification and/or higher growth, there are plenty. One option is to consider the FTSE 250 index, which is a grouping of the largest 250 companies outside the FTSE 100. With many companies within this index growing at a fast rate, it has outperformed the FTSE 100 over the last five years, returning 64%, or 10.4% on an annualised basis.
Another choice is to look at an index that tracks international shares. For example, the MSCI All Country World Index (ACWI) captures returns across 23 developed and 24 emerging countries. Over the last five years, it has returned 10.1% on an annualised basis.
So while the FTSE 100 does have its advantages and could be a good core holding, if you’re looking to enhance your diversification and potentially boost your investment returns, adding exposure to a few other indices could be a good move.
