If I had to pick just one investment on the London stock market and hold it without selling any until retirement – let’s say for 20 years – it would be a FTSE 100 index tracking fund that automatically reinvests dividends along the way.
The alternative of holding individual company shares is far less appealing, and there is not a single one on the London stock market that I would buy and hold until retirement without the option to sell along the way. Not even those in the FTSE 100 with high dividend yields like today’s out-of-favour defensive firms,. That includes utility provider SSE, cigarette producer Imperial Brands and pharmaceutical giant GlaxoSmithKline, or troubled companies, such as British Gas owner Centrica, telecoms operator BT Group and struggling retailer Marks & Spencer Group. I also wouldn’t go for large cyclical firms, such as oil leviathans BP and Royal Dutch Shell, insurance company Legal & General Group, big miner Rio Tinto and banking firm HSBC Holdings.
Picking one of those high-yielding firms to hold for 20 years is risky. For example, firms with defensive characteristics cycle in and out of favour. Their valuations can be driven high and they can cycle down, as they seem to be doing now. Suddenly, that 20-year holding period doesn’t look so clever, especially if share prices and valuations are low at the point of retirement.
You could buy a troubled firm with a high yield. But we can never be sure a recovery in operations will take place. Sometimes companies get into even more trouble and cut their dividends, which sends their share prices plummeting. They can stay down for a long time or even go bust, as we’ve seen with Carillion.
Meanwhile, cyclicals with strong profits and high dividend yields can be an accident waiting to happen. What goes up often comes down and that includes earnings, dividend yields and share prices. You could end up with a cyclical low when you are ready to retire. Sometimes cyclicals fall so hard on a down-leg that they never recover to old highs. We could be seeing that effect with large banks such as Royal Bank of Scotland Group and Lloyds Banking Group.
Spreading risk and tapping the upside
Stocks switch categories too. I used to think the big supermarkets were stable, investable defensive firms. But now I’d put the likes of Tesco, WM Morrison Supermarkets and J Sainsbury into the ‘troubled firms’ category because of the threat to their sector from up and coming big-discounting competition.
However, by investing in a collective FTSE 100 tracking fund you can spread the risk. A peak in one category could balance a trough in another. The index is self-cleaning too. Badly performing firms tend to shrink and drop out of the index and companies growing fast get promoted into the index. The presence of growing firms and recovering cyclicals tends to mean that troughs are swiftly reversed – buying the dips of the index has historically been a good idea. And the long-term trade over decades is a good one. After all, the FTSE 100 started at 1,000 in 1984, which compares to 7,000 or so today. It’s the only investment I’d buy and hold until retirement.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended BP, HSBC Holdings, Imperial Brands, Lloyds Banking Group, Royal Dutch Shell B, 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.