FTSE 100 tracker funds are popular among UK investors. That’s not really surprising as these funds provide investors with exposure to the largest companies in the UK through one security at a very low cost.
However, FTSE 100 trackers do have their flaws. Here’s a look at three reasons why they may not be the best place for your retirement savings.
A poor long-term performer
Tracker funds, in general, can be very effective investments due to the fact they provide investors with broad exposure to the stock market and eliminate fund manager fees. However, to borrow a line from Phil Oakley at Investors Chronicle, tracker funds are only good investments if the “index that you are trying to track is any good.”
Stop and think about the FTSE 100 itself for a minute. This is an index that has hardly gone anywhere in 20 years. In late 1999, it was trading just below 7,000 points. Today, it trades near 7,500 points – a gain of less than 10%.
Yes, dividends have added significantly to overall returns, but it’s hard to deny it’s been a poor long-term performer. By contrast, the S&P 500 index has more than doubled over the same time period.
Why has the FTSE 100 been such a sluggish performer? In short, it’s due to the fact many of its top constituents are low-growth companies. For example, Footsie oil companies, banks, and tobacco companies are all struggling to grow at present. This isn’t likely to change any time soon, so if you’re buying a FTSE 100 tracker, you need to be prepared for low returns going forward.
Another reason FTSE 100 trackers may not be the best investment choice is there are a number of ‘low-quality’ companies within the index that could hamper returns. By low-quality, I mean companies with high debt levels and low levels of profitability.
For example, BT Group is saddled with debt and has a huge pension deficit. Vodafone just slashed its dividend. Tesco is facing significant pressure from the likes of Aldi and Lidl. There are many more examples. And in an index of just 100 companies, individual stocks can have a significant negative impact if they underperform.
Muted dividend growth
Finally, while the FTSE 100 does offer a relatively attractive dividend yield of 4.3% right now, dividend growth could be limited in the years ahead. Footsie companies such as Shell, HSBC and GlaxoSmithKline haven’t lifted their dividends for years and look unlikely to lift their payouts significantly (if at all) in the near term. As such, dividend growth from a FTSE 100 tracker going forward could be relatively low.
A better strategy?
One way around these issues is to put together a portfolio of high-quality FTSE 100 dividend growth stocks. By focusing on companies that are growing their profits and continually increasing their dividend payouts, you could build yourself a portfolio which not only outperforms the FTSE 100 over time, but also generates an income stream that rises by 5-10% per year.
In summary, while there are benefits of investing in FTSE 100 trackers, there are certainly also drawbacks. Ultimately, you could be better off constructing a portfolio of high-quality FTSE 100 stocks and aiming to outperform the index.
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Edward Sheldon owns shares in Royal Dutch Shell and GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.