FTSE 100 vs. FTSE 250: What’s the Difference?

British index investors are often caught in a battle between choosing the FTSE 100 or the FTSE 250. Both indexes contain top-notch UK shares listed on the London Stock Exchange. Yet their historical performance and volatility levels contrast drastically. 

Let’s explore both stock market indexes in more detail and determine which is the better investment.

What is the FTSE 100?

The FTSE 100 index contains the largest 100 publicly traded UK companies listed on the London Stock Exchange based on market capitalisation. The term FTSE stands for Financial Times Stock Exchange, and it was initially launched in 1984 as a joint venture.

Today, the index has become the most popular among British investors, with a reputation for stability. Since it exclusively contains the largest enterprises, its relatively low level of price volatility is hardly a surprise. However, with corporate maturity comes lower growth. As such, the bulk of investor returns stems from dividends rather than share price appreciation.

The FTSE 100 is a market capitalisation-weighted index, meaning the largest constituent enterprises have the most significant influence over its performance. And the makeup of the index has changed almost every year since its inception, with companies rising through the ranks or falling off the bottom into the FTSE 250.

Despite only containing 100 companies, the FTSE 100 represents roughly 50% of the total value of shares listed on the London Stock Exchange.

What is the FTSE 250?

The FTSE 250 index contains the 101st to the 350th largest UK shares by market cap on the London Stock Exchange. It’s a relatively newer index than the FTSE 100, launched in October 1992. Despite containing 250 stocks, the diversified nature of this index hasn’t provided much immunity to stock price volatility. 

The smaller size of its constituents means the index is largely made up of mid-cap and even some small-cap stocks rather than the large-cap stocks found in the FTSE 100. This makes the index prone to price fluctuations and limited dividends. So much so that the index only represents around 9% of the total value of listed UK shares.

However, the smaller size of these businesses opens the door to superior growth potential if a firm is successful. As a result, despite the increased volatility, the FTSE 250 has historically outperformed the FTSE 100.

Just like the UK’s flagship index, the FTSE 250 is weighted based on market capitalisation, with its biggest constituents having a greater influence than its smallest.

Top companies on the FTSE 100 vs FTSE 250

Both indexes are rebalanced every quarter. However, as share prices and, in turn, market caps are constantly in flux, the order of the top largest companies in both indexes is constantly changing.

As of February 2023, the biggest stocks in the FTSE 100 and FTSE 250 are:

FTSE 100 vs FTSE 250: recent performance data

Since their respective inceptions, the FTSE 100 and FTSE 250 have delivered an average annual total return of 7.2% and 10.6%.

But in recent years, the performance difference between the two indexes has varied widely, with the FTSE 100 occasionally outpacing the FTSE 250.

Despite historically delivering lower returns than the FTSE 250, the FTSE 100 has actually been the better performer in four of the last seven years.¹

FTSE 100 vs FTSE 250: what are the differences?

There are several differences between the FTSE 100 and the FTSE 250, the most prominent being market capitalisation. Despite containing only 100 companies, the FTSE 100’s aggregate constituent market cap is significantly higher than the FTSE 250 index.

With coverage across all major industries, this makes the FTSE 100 a more accurate proxy for the state of the British economy. That’s one of the main reasons why analysts use it as a performance benchmark for UK shares.

It’s also worth pointing out that the FTSE 100 appears to be a better diversified index than the FTSE 250, even with fewer companies. How? Because the distribution of industries across the index is far more balanced.

The most significant industry represented in the FTSE 100 is consumer staples, at 17.9%. By comparison, 43.7% of FTSE 250 companies reside within the financials sector. 

The FTSE 250’s increased concentration is not necessarily a bad characteristic. After all, if the financial sector outperforms, the index can deliver superior returns. And with interest rates now on the rise, lending institutions are reaping the benefits of this complementary operating environment. 

However, this obviously comes with a caveat. If the financial sector suffers a downturn, the index will likely underperform severely.

Considering these differences, the FTSE 100 is often considered the more stable income-oriented index, whereas the FTSE 250 is better known for delivering superior growth at the cost of increased volatility.

Should you invest in the FTSE 100 or FTSE 250?

When it comes to deciding between the FTSE 100 and FTSE 250 for investment, there are solid arguments for both indexes. But the decision of where to invest ultimately depends on the individual investor and their personal financial circumstances as well as risk tolerance.

Someone getting closer to retirement will likely be uncomfortable taking excessive risks with their investment portfolio. As such, the heightened volatility of the FTSE 250 likely makes it an unsuitable choice. 

By comparison, a young investor just starting their professional career has far longer to build retirement savings. As such, the longer time horizon provides a sturdier buffer against volatility. Why? Because over the long term, the stock market goes up – a trend perfectly reflected by both the FTSE 100 and FTSE 250 when looking at their historical performances.

Of course, age isn’t the only factor, and retirement savings aren’t the only investment goal. A younger investor seeking to save money for a down payment on a house within the next five years may not be willing to take on excessive risk, even if their age permits it.

Ultimately, investors seeking greater returns and comfortable taking on additional short-term risk will likely find the FTSE 250 more appealing. But for those pursuing greater stability with a lucrative stream of passive income through dividends, the FTSE 100 may be more appropriate.

Regardless, it’s important to remember that the stock market can go up as well as down. And even an investment into a seemingly robust and secure index like the FTSE 100 can still result in lacklustre or even negative returns.