Lessons from the FTSE 100 record

Following the recent market volatility which has triggered  countless headlines, we’d like to share with you some of our thoughts. The headline UK index FTSE 100 reached an all-time high in April, nudging above the 7,000 mark for the first time and surpassing its previous peak of 6,930, achieved on the eve of the millennium. It has since suffered some volatility and dropped below 6,000. This begs the question: ‘Why would you invest in equities if the 15 year return is negative?’

In our view, a more realistic measure of the investment return is the total return, which includes the reinvestment of the dividend income. By this measure, £100 would have fallen in value immediately after the dot.com crash in 2000/01, but would have recovered its original £100 value at the end of 2005 and even after the dip of last week, would now be standing at £155 i.e. a 55% profit despite the index now being at exactly the same level.

The total return is a far more meaningful measure of the return you receive by investing in equities than the headline index level you see in the press, but it’s still far from representing a diversified investor’s experience over the past 15 years.

One of the key components we stress as being so important in any portfolio is diversification beyond any particular index such as the FTSE 100. This might involve holding small companies that have a history of performing better than large companies over the long term, since the start of the millennium, UK small companies have more than tripled in value. An investment in the whole UK market, measured by the FTSE All-Share (as opposed to the FTSE 100 which is so widely quoted) would have made the £100 investment grow to £179 over the same period, an increase of 79%.

Moreover, diversifying further still and investing in global markets as well as in the UK can also improve expected returns. Indeed, over this period, a global portfolio of shares (FTSE World Index) returned £186 from the initial £100 investment.

The moral of this story is that the next time you hear that one of the world’s headline indices has risen or fallen, think hard about how meaningful this news is to your fully diversified portfolio of investments. Ignoring a portfolio’s income and/or diversification could adversely impact your investment experience.

Please contact Stephen Humphreys for more information.