FTSE 100 tracker funds (ETFs) are extremely popular among UK investors these days. With many investors not wanting to take on the responsibility of picking stocks themselves, and also trying to avoid the fees charged by professional portfolio managers, a lot of people have gravitated towards cheap tracker funds designed to mimic the performance of the UK’s main stock market index at a low cost.
Is this a good investment strategy though? Let’s take a closer look at some of the advantages and disadvantages of owning a FTSE 100 tracker fund.
There are a number of advantages, of course. For starters, with a FTSE 100 tracker, you’ll get instant exposure to the UK’s largest listed companies. Through one purchase you’ll get exposure to the likes of Royal Dutch Shell, HSBC and GlaxoSmithKline. You’re therefore getting exposure to some blue-chip companies that have been around a long time.
Second, investing in a FTSE 100 ETF provides you with instant diversification because the Footsie has 100 companies. As such, you don’t need to worry about stock-specific risk.
Third, the FTSE 100 does generally offer an excellent dividend yield. Right now, the forecast yield is around 4%, so you’re likely to pick up both capital gains and income over time from a tracker fund.
However, there are also a number of disadvantages associated with a FTSE 100 tracker fund.
Firstly, while you’ll get exposure to some fantastic, world-class companies when you buy a FTSE 100 ETF, you’ll also be getting exposure to some lower-quality companies. For example, the index contains a number of stocks with high levels of debt. Do you want to be owning these companies?
Second, the FTSE 100 is a slow-moving, lethargic index. Look at a long-term chart, and you’ll see that it has literally gone nowhere in 20 years. One of the key reasons for this is that the Footsie has minimal technology exposure. This is a major flaw of the index, in my view. With the FTSE 100, you’re not going to get exposure to dominant global tech players such as Amazon, Apple and Netflix (that are having a big impact on the world).
Third, if you have ethical beliefs, you’re going to have problems investing in a FTSE 100 tracker. ‘Sin stocks’ such as tobacco and alcohol? The FTSE 100 has a number of them. Defence companies that make warships and missiles? They’re in there too. A tracker fund doesn’t give you much investing flexibility.
Finally, by definition, you’re never going to beat the market by investing in a tracker fund. If the FTSE 100 falls, your investment will fall too. If the FTSE 100 returns 2% for the year, your money will grow by 2% too (slightly less when you factor in fees). While that’s likely to suit some people, here at The Motley Fool, we believe that it’s not that hard to beat the market over time with the right mix of stocks and funds.
So, overall, while a FTSE 100 tracker does offer some advantages, it’s not the perfect investment. Ultimately, if you’re looking to generate a higher return on your money, putting together a portfolio of individual stocks and/or specialist funds, may be a better move than investing in a FTSE 100 ETF.
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Edward Sheldon owns shares in Royal Dutch Shell, GlaxoSmithKline, and Apple. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon, Apple, GlaxoSmithKline, and Netflix. The Motley Fool UK has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool UK has recommended HSBC Holdings. 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.