The FTSE 100. You have probably heard of it. But do you know what it is? Contrary to popular belief, the FTSE 100 is not a fund. It is simply a stock market index. Though there are many funds (index funds) that track the performance of the FTSE 100.
This article aims to answer any questions you have on the FTSE 100 and will look at the cheapest ways to invest in a FTSE 100 tracker fund.
What is the FTSE 100 index?
The Financial Times Stock Market 100 or the the FTSE 100 is a share index of the 100 largest companies by market capitalisation listed on the London Stock Exchange.
The FSTE 100 index is one of the worlds most famous indices along with the S&P 500 (which is an index of the 500 largest companies on the United States stock market) and the Dow Jones Industrial Average (which is tracks 30 large, publicly-owned companies trading on the NYSE and the NASDAQ)
The FTSE 100 was launched on 3 January 1984 and had a start value of 1,000.00. Since then, the make-up of the index has changed almost beyond recognition, with mergers, takeovers and disappearing companies, underlining the index’s purpose of acting as a barometer of market activity. It is changed every quarter to make sure it still reflects the top 100 companies.
How Are Companies Selected To Be Part Of the FTSE 100?
The FTSE 100 is made up of the 100 companies that have the highest market capitalisations on the London Stock Exchange.
So not by revenue, not by profit by by market capitalisation.
The market capitalisations is basically the total monetary value of a company’s outstanding shares. So if a company’s share price is £1 and has shares outstanding of 1,000,000, the market cap will be £1,000,000.
The companies on the FTSE 100 keep changing due to changes in their individual share prices prices and thus market caps. It would be chaotic to make changes to the FTSE 100 everyday due to stock market gyrations. Thus the FTSE 100 undergoes changes on a quarterly basis to ensure that it only plays hosts to the top 100 companies listed in the U.K main market. However, if takeovers or mergers take place before quarterly changes go into effect, the changes have to be factored in accordingly to ensure the index maintains its status as an index of the top 100 companies.
At these quarterly meetings, the governing council tasked with adding or removing companies from the FTSE 100 follow a banding process. If the market cap of an eligible company rises and falls within the top 90 companies in the FTSE 100, the council is obliged to add it and downgrade one company to the second tier index (FTSE 250). Conversely should a market cap of the company in the FTSE 100 fall below the 111th position it is removed from the higher tier and added’ to the FTSE 250.
To be eligible to be included in the FTSE 100, a company must pass a number of criteria. The eligibility criteria can be found here :https://www.ftse.com/products/downloads/FTSE_UK_Index_Series.pdf
What Companies Make Up The FTSE 100 index
The companies that constitute the FTSE 100 as of 1 April 2019 are:
3i Grp. (III)
Admiral Grp (ADM)
Anglo American (AAL)
Ashtead Grp. (AHT)
Babcock Intl (BAB)
Bae Sys. (BA.)
British American Tobacco (BATS)
British land (BLND)
Bt Group (BT.A)
Burberry Grp (BRBY)
Capita Group (CPI)
Cocacola Hbc Ag (CCH)
Compass Group (CPG)
Direct Line (DLG)
Dixons Carpho (DC.)
Hargreaves Lans (HL.)
Hsbc Hldgs.uk (HSBA)
Intercon. Hotel (IHG)
Intertek Group (ITRK)
Intl Consol Air (IAG)
Intu Properties (INTU)
Johnson Matthey (JMAT)
Land Secs. (LAND)
Lloyds Grp. (LLOY)
Marks & Sp. (MKS)
Morrison (Wm) (MRW)
National Grid (NG.)
Rds ‘A’ (RDSA)
Rds ‘B’ (RDSB)
Reckitt Ben. Gp (RB.)
Rio Tinto (RIO)
Rolls-royce Hlg (RR.)
Royal Bank Scot (RBS)
Royal Mail (RMG)
Rsa Ins. (RSA)
Sage Grp. (SGE)
Severn Trent (SVT)
Smiths Group (SMIN)
St.james’s Plac (STJ)
Travis Perkins (TPK)
Tullow Oil (TLW)
Utd. Utilities (UU.)
Vodafone Grp. (VOD)
Weir Grp. (WEIR)
How Much each company makes up of a FTSE 100 index depends on the market capitalisation. The higher the market capitalisation, the higher the weighting it has in the FTSE 100.
The current highest weighted shares/companies on the FSTE 100 are HSBC, Royal Dutch Shell, BP, AstraZeneca, Glaxosmithkline, Diageo, British American Tobacco, Rio Tinto and Lloyds Banking Group.
How To Invest In The FTSE 100.
The best cheapest way to invest in the FTSE 100 is via index funds. The following are some index funds that track the FTSE 100.
Who are Index Funds such as the FTSE 100 good for?
Warren Buffet Said the following about index funds in one of his Berkshire Hathaway annual shareholder reports:
My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.
There you have it. That should be the biggest thing going for index funds – a seal of approval from the sage of Omaha himself.
Other advantages of index funds are:
- Low Expenses – Keeping costs low are a large advantage for index funds and the cost savings translate to higher returns for the investor. Just look at Warren Buffett’s bet against actively managed hedge funds.
- Passive Management – For investors that are pressed for time in their everyday life or for those not fully clued on to the quirks of accounting, index investing may be the way to go. Instead of actively buying and selling stocks which we individual investors are terribly bad at, index investors are seeking only to buy and hold securities that represent the given index for purposes of matching the performance of the index, not to beat it.
Disadvantages of buying an index fund:
As well as the FTSE 100 having its advantages, it has disadvantages too. Some disadvantages are:
- Buying into bad businesses – Not all business create value for shareholders. There are some industries such as banking I will never touch. The economics of the baking industry are bad for shareholders as the majority of value flow to employees (bankers) due to high bonuses. Additionally I would not want to invest in insurance companies or mining companies except in very rare instances. By buying into the FTSE 100 index, you are buying a share in each of the companies, even the bad ones.
- Buying into overvalued companies – As the FTSE 100 is a market weighted index, the weightings of companies are not based on revenues or profits but simply based on market capitalisation. This means that if a stock price is overvalued, it could have a higher weighting in the index and thus you would buy more of it. And you and others buying it makes the share price shoot even higher thus causing it to become even more overvalued. It is a giant momentum strategy based on fund inflows.
- Does’t Provide As Much Diversification As You Think –Yes, you read that right! Contrary to popular belief, index funds don’t offer much diversification.
Looking at the FTSE 100 for instance, the top 10 holdings make up 48.78% of the index. This means that the 90 other companies in this index make up only 51.22%, which is less than 0.57% each. And when it comes to dividends, the FTSE 100 is even worse. 7 companies pay 79.8% of the total FTSE100 dividend. Shell and BP alone pay 15.3% and 7.6% each.
So on the face of it, you might think that a FTSE 100 index is great as you are buying into 100 different companies and that one or two companies performing bad will not affect your portfolio. But if those companies happen to be Shell, BP, HSBC or any of the major companies that have high weighting on the index, the whole index will be dragged down even if the majority of companies share price goes up. How’s that for diversification.