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Forget The FTSE 100: The Real Money Is Made In The FTSE 250

Buying a FTSE 100 tracker fund is a great way to steadily build wealth over time. A tracker fund gives you exposure to the whole FTSE 100 index and all of its constituents — a ready built, well-diversified portfolio at a low cost and minimal effort.

And Warren Buffett, the world’s most successful investor, has long advocated this approach as, over the long term, indexes usually outperform regular investors.

Indeed, over the past two decades the FTSE 100 has risen at a rate of around 5.4% per annum, excluding fees, dividends and inflation — dividends received are likely to cancel out fees and inflation anyway. In comparison, over the same 20-year period, according to research conducted by a number of financial institutions, the average investor has only returned 2.5% per annum including dividends. This paltry return is, in a word, shocking.

However, while the FTSE 100’s slow-and-steady performance has outperformed the average investor, the FTSE 250 has been able to clock up an even more impressive rate of growth.  

In particular, over the past ten years, the FTSE 250 has outperformed its blue-chip peer by around 90%, excluding dividends. Figures from financial data company Morningstar show how these returns would have stacked up for investors on an annualised basis. 

According to Morningstar, the  iShares FTSE 100 UCITS ETF (Dist) (GBP) tracker returned 6.9% per annum for the past ten years. The fund, one of the cheapest on the market, charges 0.4% per annum in management fees and supports a dividend yield of 3.40%. 

Meanwhile, the iShares FTSE 250 UCITS ETF (GBP) has returned 11.3% per annum for the past ten years.  That’s nearly 5% per annum more than the FTSE 100. What’s more, the FTSE 250 tracker offers an annual dividend yield of 2.5%.

Looking at a shorter time horizon, the FTSE 250 tracker has returned 14.8% per annum during the past five years, a full 7.9% more per annum than its blue-chip peer. 

Nevertheless, the FTSE 100 does have its advantages. At present the FTSE 100 trades at an average P/E of 15.8 and offers a yield of 3.40%, with the average yield covered 1.8 times by earnings per share. The FTSE 250 is slightly more expensive as it currently trades at an average P/E of just under 19 and supports a yield of 2.6%.

If you’re an income investor, the extra 0.80% per annum in yield offered by the FTSE 100 proves a welcome income boost. Although, for investors with a long-term time horizon, the FTSE 250 makes up for its lack of income with impressive capital gains. 

Moreover, it’s not just the FTSE 250 that’s making the FTSE 100 look bad. After a quick look around, it is easy to see that there are plenty of other, more lucrative opportunities out there.

For example, over the past ten years Unilever’s shares have produced a total return of 12.9% per annum, more than double the return achieved from a standard FTSE 100 tracker fund including fees.

Now, you may be thinking that I've just cherry picked Unilever because the company's returns are better than average, but that's not the case. Indeed. Unilever has actually been picked by the Motley Fool's top analysts as one of the top five shares you should hold in your investment portfolio, due to the company's defensive nature and hefty dividend payout. 

And if you would like to uncover the other four stocks we believe should have a place in your investment portfolio, download our free report today!

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.