New investors should look beyond the FTSE 100.
If you're just getting started in investing, an index tracker makes good sense. It gives you exposure to a broad selection of stocks at lower risk and cost than investing in a few individual companies or an expensive actively managed fund.
You'll probably want to stick close to home to begin with, and choose a UK tracker.
Which index?
There are four main indices in the UK:
- FTSE 100 -- the largest 100 companies;
- FTSE 250 -- the companies ranked 101 to 350;
- FTSE Small Cap -- about 280 smaller listed companies; and
- FTSE All-Share -- the aggregation of the FTSE 100, FTSE 250 and FTSE SmallCap indices.
FTSE 100 trackers are very popular, as are All-Share trackers. There are a few FTSE 250 trackers on the market, too, but no Small Cap tracker.
Because the individual companies in the indices are weighted proportionally by size, there is less difference than you might imagine between a FTSE 100 and All-Share tracker.
The FTSE 100 represents over 80% of the All-Share and dominates its performance. The FTSE 250, accounting for 15%, makes a relatively small contribution, whilst the contribution of the Small Cap, which represents as little as 2%, is negligible.
FTSE 100
As the table below shows, the 10 biggest companies in the FTSE 100 represent nearly half of the index:
The top company, Shell, is more than 50 times bigger than the company ranked 100.
A FTSE All-Share tracker reduces the concentration of the biggest companies, but not by a great deal: the top 10 account for nearly 40% of the All-Share.
FTSE 250
In the FTSE 250 the weightings are more balanced. As the table below shows, the 10 biggest companies represent just over 10% of the index:
The difference in size between the biggest and smallest companies in the FTSE 250 is also significantly less than in the FTSE 100.
The companies at the lower end of the FTSE 250 are no obscure tiddlers. Worth £300m+, they include such names as Yellow Pages directories firm Yell (LSE: YELL), retail chain JD Sports (LSE: JD), and comparison website Moneysupermarket.com (LSE: MONY).
Don't ignore the FTSE 250
FTSE 250 trackers are less popular with new investors, and there are fewer products on the market, but there are two very good reasons for holding such a tracker alongside either a FTSE 100 or All-Share tracker.
First, FTSE 250 firms have more scope for growth than the elephantine companies of the top index. Historically, the FTSE 250 has outperformed the FTSE 100 over the long term, although for short spells the FTSE 100 has done better.
Second, holding a FTSE 250 tracker as well as a FTSE 100 or All-Share tracker improves the overall balance of the individual companies, reducing your reliance on the performance of just a few very large firms.
Split for growth
A simple 50/50 split between FTSE 100/250 trackers (or 55:45 FTSE All-Share/250 split for a similar result) gives you meaningful exposure to the higher growth potential of the FTSE 250.
Such a split also dilutes the dangerous concentration in the biggest firms by reducing the contribution of top company Shell from 8% to 4%, and likewise halving the whopping 50% contribution of the top 10.
In short, whilst FTSE 100 and All-Share trackers are heavily marketed, it's well worth considering blending one of them with a FTSE 250 tracker.
In for the long term
In the short term markets can be volatile and you need to be prepared to see the value of your investment fall at times -- and, on occasions, quite alarmingly.
As legendary investor Warren Buffett has put it: "Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."
In the long term, though, equities have the potential for superior returns to cash and other asset classes, such as bonds. The longer your investment horizon the better.
Even in the Noughties, the so-called 'Lost Decade For Shares', a young investor regularly feeding money into trackers would be well on course for achieving long-term capital growth.
More from G A Chester:
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