3 reasons why the FTSE 250 beats most investors

Beating the wider index is a great aim, but not every investor is able to do so. That’s especially the case with the FTSE 250 since its returns are generally much higher than the FTSE 100. As such, while many investors can beat the FTSE 100, few are able to beat its ‘little brother’.

In fact, the FTSE 250 has outperformed the FTSE 100 by 36% in the last five years and by 64% in the last 10 years. While some investors will have beaten both indices, those who have outperformed the FTSE 250 are probably in the minority since its returns have been highly consistent and very strong.

Diversity counts

One reason for this is the sheer diversity of the FTSE 250. As its name suggests, the index contains a large number of individual companies and this significantly reduces company-specific risk. This means that when one of the FTSE 250’s constituents has a profit warning or its share price falls for whatever reason, the value of the index isn’t severely dented.

This isn’t the case for many private investment portfolios. A lot of private investors will typically hold only a handful of stocks within their portfolio and while this high level of concentration can lead to higher returns if the stocks perform well, the reality is that poor share price performance from at least one stock is very difficult to avoid. As such, their portfolio returns are hurt more significantly by a small number of underperformers than is the case for the FTSE 250.

In it for the long haul

A second reason for the FTSE 250’s outperformance versus most investors is its long-term view. While there are promotions and relegations to and from the FTSE 250, the vast majority of its incumbents remain in the index for many years. This means that their strategies and business plans have the time they need to come good, deliver higher profitability and allow the company’s share price to rise. Investors on the other hand can be much more impatient and look to sell when in profit or else engage in short-term trading. This can simply increase costs and lead to reduced overall returns in the long run.

A third reason why most investors fail to beat the FTSE 250 is that the index has 100% exposure to mid-caps. Historically, they’ve offered superior returns to their larger peers because they’re often less mature and more focused on growth as opposed to diversity or paying high dividends.

Risk vs reward

With a significant proportion of investors focusing on large caps due to their higher yields and perceived lower risk, their returns are often below those of the FTSE 250. By pivoting towards mid-caps, an investor’s risks may increase but the potential rewards could do the same. Therefore, for many investors switching their allegiance away from the FTSE 100 and towards the FTSE 250 could prove to be a sound move.

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Peter Stephens 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.