Financial experts often say that shares, as an asset class, are capable of generating returns of around 8% per year or so over the long run. As such, many people base their retirement planning calculations on that kind of long-term return figure.
However, the problem for UK investors is that over the last five years, the FTSE 100 index hasn’t generated anything like this figure. According to the latest FTSE 100 factsheet dated 31 August, the index only generated an annual return of 5.3% per year for the five-year period to the end of August.
I don’t know about you, but I think 5.3% per year is a pretty poor return from the stock market, particularly when you consider that for much of that five-year period, global equities were in a strong bull market. By contrast, the US’s S&P 500 index generated annualised returns of 10.1% per year over the same investment horizon.
Sure, 5.3% is a much higher return than you’d get from a Cash ISA. However, when you factor in the risk that you’re taking on by investing in stocks (i.e. the stock market can fall 20% in the blink of an eye), 5.3% per year is disappointing in terms of compensation.
The problem with the FTSE 100
That said, I’m not overly surprised by the FTSE 100’s low returns. It’s an issue I’ve warned investors about before. The problem is, in my view, the index is filled with low-growth companies. When the biggest companies include oilers, banks, and tobacco producers, you simply can’t expect high returns from the index as these industries are all struggling for growth.
For this reason, I’m taking steps to diversify outside the FTSE 100 in order to target higher returns.
Aiming for higher returns
One thing I’ve done in recent years that’s paid off handsomely is boost my exposure to the US as many of the world’s fastest-growing large-cap companies are listed there. I’ve done this by investing in global equity funds such as the Fundsmith Equity fund, which has substantial exposure to the US. Over the last five years, this fund has generated a return of 172% – far, far higher than the return from the FTSE 100.
I’ve also boosted my returns by investing in smaller AIM-listed companies. These can be more volatile than FTSE 100 stocks so you don’t want to be overexposed to them. However, a little bit of exposure to this area of the market can really pay off. For example, with stocks such as fast-growing digital marketing group dotDigital and identity specialist GB Group I’ve doubled my money.
The takeaway here is that if you’re looking for healthy returns from stocks, it can pay to look outside the FTSE 100. If all your stock market exposure is through a related tracker, you may be disappointed by your overall investment returns.
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Edward Sheldon owns shares in dotDigital Group and GB Group and has a position in the Fundsmith Equity fund. The Motley Fool UK has recommended dotDigital Group. 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.