The Arguments For and Against Investing in the FTSE 100

The FTSE 100, affectionately known as the ?Footsie? by City traders, is an index of 100 of some of the largest UK companies listed on the London Stock Exchange.

It?s a weighted index, which means that the price swings of large firms have more impact on the index value than smaller firms that make up the list.

The arguments against investing in the FTSE 100 index:

Most of the arguments against using the FTSE 100 index stick to a common theme: You?re not as diversified as you think when investing in this basket of 100 companies.

1. The weighting of the index is extremely skewed towards the top ten firms

At the time of writing, the largest firm in the FTSE 100 is the pharmaceutical giant AstraZeneca, which has a market capitalization of £160bn. The smallest member is Habour Energy PLC with a market cap of £3bn.

As FTSE weights the index by market capitalization, this means that AstraZeneca makes up 53 times more of the index than Habour Energy.

The effect of this cannot be underestimated. In a day where AstraZeneca shares fall by 2% and Habour shares rise by 2%, the value of the FTSE 100 would fall by 2%. Therefore while it may appear like you are evenly spreading your money across a huge list of companies, in reality, you are investing the vast majority of your money in the top 20 companies, with only a tiny fraction actually being exposed to the other firms.

2. With few firms really driving the overall index value, the sector spread is also not as diverse as it could be.

The FTSE 100 is dominated by industries that you could argue have seen their best years already; Mining companies, Oil & Gas Companies, and Banks. Tech is notably underserved by the index, owing to many of the largest tech listings occurring on US soil over the last two decades.

If you had invested in the FTSE 100 twenty years ago, you would have seen no benefit from the growth of Google, Apple, Amazon, Facebook, Microsoft, or Netflix.

3. FTSE 100 performance has lagged behind the S&P 500

Past performance is not a guarantee of future returns, but the past performance of the FTSE 100 looks bleak in contrast to S&P 500. When performing your own research, you should be wary of simply comparing the S&P 500 price chart with the FTSE 100 graph as this isn?t necessarily a fair comparison. This is a point that finance blog Financial-Expert.co.uk takes pains to clarify: ?Neither chart includes the effect of dividends being paid to investors, and the FTSE 100 is home to high dividends.?

Even still, when dividends are factored in, investors have seen greater returns in the S&P 500 than in the FTSE 100 over the last two decades.

The reasons for this are several; the US has seen enormous success in growing global tech giants that now enjoy monopolistic positions in their respective industries. The UK has also committed an act of economic self-harm in the shape of the Brexit vote which saw the UK leave the European Union, and has had a negative impact on business.

The argument for investing in the FTSE 100

1. In many ways, the FTSE 100 ?is? the stock market

The FTSE 100 represents most of the ?UK stock market?. While the weightings are skewed towards the larger firms, this indeed reflects the make-up of the stock market itself. Therefore any investor looking to capture the headline returns offered by the whole stock market should be investing accordingly.

2. Reduction of foreign exchange risk

Companies in the FTSE tend to have large UK operations (some of them exclusively), which means that they are less impacted by foreign exchange risk. When retail investors put their money in foreign index funds, they are exposed to more foreign exchange risk against the British Pound Sterling.

Foreign exchange risk cannot be totally avoided, but our desire to avoid unnecessary price volatility provides a natural incentive for British residents to invest in their domestic stock market, which for us means investing in the companies that make up the FTSE 100.

3. Cost-effective investment

FTSE 100 index funds also carry very low fees compared to the trading costs that you would incur if you tried to build a DIY portfolio of your own selection of UK companies. The lowest ETF management charge is currently less than 0.1%. That?s just £100 on an investment of £100,000. This makes investing through index funds a very cost-effective way to access stock market returns.

Overall

This article isn?t financial advice. Ultimately the choice of whether to invest in the FTSE 100 is yours to make. There are several attractive qualities that draw hundreds of thousands of investors to place their money in investments linked to the FTSE 100 index, but it?s by no means the king of stock market indices, so you may want to look elsewhere and consider allocating some of your wealth to other indices too.

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