The stock market offers an incredible range of choice for investors. Even the blue-chip FTSE 100 index allows us to choose between many different types of company.
Good news, right? You can invest your cash and get exactly what you want.
Maybe. Or maybe not. There are some problems with investing in individual stocks. In this article I’ll explain why I think it makes much more sense to buy a FTSE 100 index tracker than to buy individual stocks.
Avoid this big risk
To get a balanced, diversified portfolio of shares, most investors agree that you need somewhere between 15 and 30 stocks.
If you’re investing £1,000, you won’t have enough cash to achieve this. Investing in 15 stocks would only give you £66 per stock. Typical dealing costs of £10 would eat up 15% of your cash. It’s just not practical.
If you opt to put your money into just one or two stocks, then you run the risk of massive losses if anything goes wrong. All investors make mistakes and suffer big losses sometimes. As outsiders, we can never know everything about what’s happening inside a business.
The best way to protect yourself against this risk is through diversification. This means investing in a range of unrelated businesses, so that problems at one company will only have a small overall impact on your portfolio.
I reckon that investing in a FTSE 100 index tracker is the simplest way to achieve effective diversification. Even if you only invest small amounts, you get diversified exposure to about 100 companies, including well-known names such as Unilever, Shell, Tesco and Lloyds Bank.
A safe 4.6% income?
Most of the businesses in the FTSE 100 are large and fairly mature. Unlike many smaller companies, they don’t need to invest all of their profits in growth opportunities.
Instead, a significant amount of each year’s profits are paid out in cash to shareholders. This is the dividend. It’s similar to interest on a savings account, except that dividends are not guaranteed.
However, although individual companies may cut their dividend in a given year, most will not. The dividend income available from the FTSE 100 is fairly stable.
At the time of writing, the FTSE 100 offered a dividend yield of 4.6%. That means that the companies in the FTSE are expected to pay out 4.6% of their market value in dividends this year.
This yield is above the historical average for the FTSE 100. It looks attractive to me. I can’t think of any other investments that will provide this level of income to investors in a cheap and simple investment.
I think it’s the right time to buy
Political uncertainty is high. There’s no way of knowing whether the stock market will go up or down this autumn. But it’s worth remembering that many of the big companies in the FTSE 100 make most of their money outside the UK. Brexit may not have much impact on them.
History suggests that over long periods, the stock market tends to rise. In the meantime, investing in a FTSE 100 tracker fund will give you a reliable income that can be reinvested to boost your returns, or withdrawn in cash.
Uncertainty may be holding the market back — but such problems are usually solved eventually. I think that now could be a good time to buy a FTSE 100 tracker fund.
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Roland Head owns shares of Royal Dutch Shell B and Tesco. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended 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.