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Should you buy a FTSE 100 tracker fund or shares? Here’s what I’d do now

The FTSE 100 has fallen by about 20% over the last month. But the individual stocks in the index have delivered a much wider set of results.

According to the latest data I’ve seen, at least 75 of the index’s 101 members have fallen by more than 20% over the last month. In other words, they’ve lagged the market.

Investors who own these stocks might have had better results if they’d put their cash into a FTSE 100 tracker fund.

Today I want to look at the pros and cons of tracker funds, and explain how I’m investing my cash in the FTSE 100.

The story so far

The FTSE 100’s fall has been scary enough. But take a moment to consider shareholders in cruise ship operator Carnival and British Airways owner IAG. Shares in both firms have fallen by 65% over the last month. I suspect both companies may need some form of refinancing, so dividends might be ruled out for a few years.

That’s the bad news. But at the top end of the market, Ocado shareholders have seen an 11% rise over the last 30 days. The online supermarket is one of only two FTSE 100 stocks to print a gain over this period.

We can see from these examples that if you own the whole index through a tracker fund, you get the average performance. If you own individual stocks, you’re results might be better. But they may also be much worse.

FTSE 100: need to know

In general, I think that drip-feeding money into a FTSE 100 tracker fund is a good way to build a retirement fund without too much risk.

However, there are a few things you need to know about the big-cap index. The way the FTSE 100 is constructed means that the 10 largest companies in the index account for more than 40% of its value.

This includes firms such as Royal Dutch Shell, BP, GlaxoSmithKline, British American Tobacco, HSBC Holdings, and Unilever. If you invest in a FTSE 100 tracker, your portfolio will be heavily weighted towards companies like these, whether you like it or not.

On the other hand, high-quality companies that are smaller but may have better growth prospects will only account for a tiny fraction of your investment. FTSE 100 companies I’d include in this category include highly successful companies such as Auto Trader, Bunzl, and Burberry.

A more equal exposure to different sectors of the market could improve your results, over long periods.

What I’d do now

Although the FTSE 100 enjoyed a solid bounce on Tuesday, the reality is that stock markets are still very volatile. The situation in the UK and many other countries is still highly uncertain.

I’d be quite comfortable buying into a FTSE tracker fund in the current environment. I’m pretty sure the index offers good value at current levels, close to 5,500.

However, my preferred strategy is to invest in a more balanced mix of stocks, spread across all the main sectors. I target a portfolio of around 20 stocks, evenly weighted.

Although this carries the extra risk of investing in a company where things go wrong – I own Carnival — I hope that over time, my even diversification will help me to beat the FTSE 100.

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Roland Head owns shares of British American Tobacco, Carnival, GlaxoSmithKline, and Royal Dutch Shell B. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended Carnival and 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.