The FTSE 100 index is extremely popular with UK investors. Drawn in by well-known household names and attractive dividend yields, many have the bulk of their retirement savings in FTSE 100 stocks, whether that’s invested in individual companies, mutual funds, or exchange-traded funds (ETFs) which track the index.
Investing predominantly in the FTSE 100 could be a dangerous investment strategy though, in my view. Relative to other indices, the leading UK index has a number of major flaws, and could be set to face a number of headwinds in the years ahead. This means growth could be subdued and investment returns could be underwhelming.
Ultimately, if you’re looking for robust returns from your investment portfolio, I believe that it’s essential to have some exposure to stocks outside the FTSE 100.
One of the key flaws of the FTSE 100 is that it’s concentrated in low-growth sectors. For example, take a closer look at the index and you’ll find it has large exposure to oil, supermarket, and tobacco stocks – which are all likely to face headwinds in the years ahead. Many of these stocks have been winners in the past, but there are question marks over whether they will be the winners of tomorrow.
Lack of technology
At the same time, the FTSE 100 has a worryingly small amount of exposure to the fast-growing technology sector. Many technology companies across the world are growing at a prolific pace right now and generating fantastic returns for investors in the process.
However, if you’re invested entirely in the FTSE 100, you’re likely to miss these gains. Currently, the index has just 0.8% exposure to technology, while the MSCI All World Index has 16.3% exposure.
Another issue for those focused on the FTSE 100 is that since the early 2000s, UK growth has continually lagged behind global growth. Back in the 1980s and 1990s, UK GDP growth was generally on par with global GDP growth, so it made sense to invest in the UK.
However, times have changed and over the last few decades UK growth has significantly underperformed that of other major countries, such as the US and China. I realise that many companies in the FTSE 100 operate globally. However, there are still plenty of names within the index that are more domestically focused such as Lloyds Bank, Tesco, and ITV. For these companies, subdued UK growth could be a headwind.
Look outside the FTSE 100
Ultimately, if you’re looking for strong returns from your investment portfolio, it could be wise to invest outside the FTSE 100.
One sensible strategy is to add some exposure to international stocks. This could be achieved through an ETF designed to track global equities or US equities for example. Or you could invest in a global fund, such as the Fundsmith Equity fund or the Lindsell Train Global Equity fund which have both smashed the FTSE 100 over the last five years.
Another option is to consider mid-cap and small-cap stocks. These tend to grow faster than large-cap FTSE 100 stocks and produce higher returns over time.
I’m not saying investors should have no exposure to the FTSE 100. There are many fantastic companies in the index. However, having all your capital in the index is a risky strategy, in my view.
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Edward Sheldon owns shares in Lloyds Bank and ITV and has positions in the Fundsmith Equity Fund and the Lindsell Train Global Equity fund. The Motley Fool UK has recommended ITV, Lloyds Banking Group, 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.