Stock picking can be tough. Even the pros get it wrong half the time, and most investors just don’t have the time to research individual companies in depth.
For the majority of investors, then, the best way to invest and build wealth is to buy a low-cost tracker fund. A tracker fund gives you a ready made, well-diversified portfolio at a low cost and minimal effort. Many investors choose to buy a tracker that invests in the UK’s leading index, the FTSE 100.
However, while the FTSE 100 is the UK’s leading index, its performance leaves a lot to be desired. Indeed, over the past two decades the FTSE 100 has produced a total return of around 5.8% per annum, and that’s including fees and dividends.
On the other hand, over the past decade the FTSE 250 has produced a total return of 11.5% per annum. £1,000 invested in the FTSE 250 ten years ago would be worth £3,258 today. A similar investment in the FTSE 100 would be worth only £1,925 today.
One of the biggest problems with the FTSE 100 is the fact that the index isn’t really a marker of UK economic strength. More than three-quarters of the index’s profits come from outside of the UK, making it a global index that’s extremely sensitive to global economic shocks.
What’s more, the FTSE 100 is a market cap weighted index, which means that it can become extremely bias towards one sector during times of market excess. For example, during the late 90s, the FTSE 100 became a tech index, as the valuations of technology companies exploded, eclipsing the performance of other sectors.
Then again, during 2007 the banking sector took over the index. Ultimately, when both of these bubbles popped, the FTSE 100 couldn’t escape the turbulence.
In comparison, the FTSE 250 is an index consisting of the 101st to the 350th largest companies listed on the London Stock Exchange, and, as a barometer of UK economic performance, is more accurate than the FTSE 100.
You see, the FTSE 250 is a UK index. Almost all of the companies listed on the index are UK born and bred. Moreover, due to the size and diversification of the FTSE 250, there’s less volatility for investors to deal with.
Figures speak for themselves
When comparing the FTSE 100 and FTSE 250, the numbers really do speak for themselves. Over the past 16 years, the FTSE 250 has risen by over 202%, excluding dividends. However, over the same period the FTSE 100 has only gained a dismal 1.8% — that’s not a typo.
After accounting for inflation of 3.6% per annum over the period according to the retail price index, the FTSE 100 has returned 2.2% per annum in real terms since 2005, including fees and dividends. Over the same period, the larger FTSE 250 has produced a real return of 7.9% per annum.
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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.