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Which FTSE tracker should I buy?

You’ve paid off any high-interest debt. You’ve built a fund of cash to guard against a rainy day. You’ve discovered that over long periods the stock market has outperformed other assets, and you’re ready to invest.

Like many first-time investors, you may have decided to go for a FTSE UK index tracker, and you’re now trying to figure out which FTSE index is the best to buy. In this article, I’ll go through the options and their key characteristics, and hopefully by the end you’ll have a clearer idea.

Options

Low-cost trackers are available for the three main FTSE UK indexes. The indexes are the FTSE 100, the FTSE 250 and the FTSE All-Share.

The companies in the indexes are weighted by market capitalisation (market cap, for short). This simply means the bigger the company, the more its performance contributes to the index.

The FTSE 100 consists of the 100 stocks with the biggest market caps. Most are multinational giants and household names, like BP, HSBC and Unilever. The biggest of the lot, Shell, has a market cap of around £190bn (and a weighting of over 10% in the index). Companies at the lower end, such as Marks & Spencer, ITV and Rightmove, have market caps around the £4bn mark, and weightings of about 0.2%.

The FTSE 250 consists of the next-biggest 250 companies after the FTSE 100. Their market caps range from around £4bn down to around £700m. You’ll still find a fair few familiar names in the FTSE 250, including Royal MailNational Express and Greggs.

Finally, the FTSE All-Share consists of all the companies in the FTSE 100 and FTSE 250, plus all the companies in the FTSE SmallCap index. There are currently around 270 in the latter, with market caps between about £700m and £130m and one or two household names among them, such as Halfords. There are no trackers available for just the FTSE SmallCap index.

Which tracker should I buy?

The FTSE 100 is a popular pick with new investors and has a decent long-term record. Historically, though, the price you pay for the comfort of being invested in largely global giants has been a somewhat lower return than the FTSE 250. For example, the HSBC FTSE 100 Index fund has delivered a five-year total return (includes reinvested dividends) of 28%, compared with 37% for its FTSE 250 tracker. Investors looking to build a large capital sum over the long term may be better served by the FTSE 250.

However, while the mature behemoths of the FTSE 100 generally have less scope for growth than the FTSE 250 ‘mid-caps’, they do pay more generous dividends. The running yield on the HSBC FTSE 100 Index fund is currently 4%, compared with 2.8% for its FTSE 250 tracker. Therefore, the FTSE 100 may be a better choice for investors wanting an immediate income from taking annual dividends in cash — for example, to supplement a pension in retirement. In this case, you’d want to invest in the tracker’s ‘income units’, as opposed to its ‘accumulation units’ that automatically reinvest your dividends.

Finally, weighting by market cap means a FTSE All-Share tracker is around 85% FTSE 100, 15% FTSE 250 and 5% FTSE SmallCap. HSBC’s All-Share tracker has delivered a five-year total return of 31% and carries a running dividend yield of 3.9%. It may not be the optimal choice for long-term capital growth or immediate income, but it might be considered a good all-rounder, with attractive diversification across the market cap scale.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended HSBC Holdings, ITV, and Rightmove. 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.