The FTSE 100, or Financial Times Stock Exchange 100, is the UK’s flagship stock market index that contains the largest 100 companies listed on the London Stock Exchange by market capitalisation. And this guide explains how to invest in the FTSE 100.
It’s one of the most popular indices used by UK investors as a benchmark against their own investment portfolios. Furthermore, the index represents just over 50% of the total value of UK equities.
Pairing the vast scope of the FTSE 100 with a fair diversification of companies across different industries, professional investors often view the index as a proxy for the overall British stock market and the UK economy.
How to invest in the FTSE 100
A stock market index isn’t a tradeable security. Therefore it isn’t possible to invest in the FTSE 100 directly. However, a broad range of mutual funds and exchange-traded funds are purposefully built to replicate the performance of an underlying index.
Investors can indirectly invest in a stock market index by investing in these so-called index funds.
1. Open a brokerage account
An investor needs to have a brokerage account to access and invest in the financial markets. These are sometimes referred to as investment accounts.
There are various types of brokerage accounts to choose from. And each offer different features, advantages and drawbacks. Investors need to consider their personal circumstances and intended investing strategy when deciding what type of account is suitable.
- Standard Account – This is the most common type of investment account. Investors deposit capital which can then be used to invest in an array of financial products, including stocks, bonds, mutual funds, trusts, and ETFs. In the United Kingdom, all capital gains and dividends received through investments in a standard trading account are subject to tax.
- Employer-Sponsored Retirement Account – This is a special investment account with certain tax benefits. However, withdrawals from this account are limited until investors reach a certain age. They are designed to be a saving instrument for pensions. The most common type of employer-sponsored retirement account in the United States is a 401(k).
- Stocks and Shares ISA Account – This is a special tax-efficient investment account for British investors only. All capital gains and dividends received from investments within a Stocks and Shares ISA are tax-free. However, investors are limited to depositing a maximum of £20,000 per year.
- Self-Invested Personal Pension (SIPP) Account – This is a special tax-deferred investment account for British investors only. Capital gains and dividends received from investments are protected from tax. However, investors cannot withdraw any funds until reaching the age of 55 (57 from 2028). When funds are taken out, they are taxed as regular income.
2. Pick an index fund
With an investment account open, the next step is to pick a suitable index tracker fund. For individuals seeking to invest in the FTSE 100, a FTSE 100 index tracker fund is required. However, investors also need to consider what type of index fund they want to own – a mutual fund or exchange-traded fund (ETF).
A mutual fund is not traded on an exchange. Instead, orders to buy and sell shares within a mutual fund are settled once daily at the end of each trading session. On the other hand, ETFs are traded on an exchange and orders are executed instantly.
There are additional differences between the two investment vehicles that investors should be aware of. We’ve written a complete guide that can be accessed below.
Beyond deciding on the index fund type, additional factors must be considered.
- Expense Ratio – As index tracker funds are typically passively managed, the annual management fees are fairly low. However, they are not zero. And some may even charge entry fees when first buying shares and/or exit fees when selling shares. The expense ratio combines all these costs, which adversely affects the overall return on investment. On average, the expense ratio of a passive fund typically lies between 0.05% and 0.15%. Generally speaking, investors should focus on the funds that charge the lowest fees.
- Minimum Investment Requirements – Some index tracker funds require investors to purchase a minimum amount of shares. This is typically more common among certain mutual funds rather than ETFs. Nevertheless, minimum investment requirements could create barriers to entry for lower net-worth investors.
- Dividends – All shareholders in an index fund are entitled to receive dividends from the companies inside the fund’s investment portfolio. However, depending on the dividend policy, any received income may be automatically reinvested into the fund’s portfolio rather than distributed to shareholders’ investment accounts. This type of dividend policy is more commonly referred to as accumulation.
An investor could reduce their expense ratio to zero by not investing in an index fund but instead buying the individual stocks of the index themselves.
However, this approach would likely rack up many transaction and commission fees in practice. It also requires more effort as portfolio rebalancing would no longer be handled by a professional fund manager but rather the individual investor themselves. In other words, taking this alternative approach is unlikely to be cost-effective.
3. Buy shares in the index fund
With a brokerage account opened and an FTSE 100 index fund selected, investors can now buy shares and replicate the index’s performance.
As a reminder, if shares in a mutual index fund are purchased, the transaction will not be executed until the end of the current or next trading session. However, trades for an index ETF will be executed instantly while the stock market is open.
Advantages of investing in the FTSE 100
Buying shares in an FTSE 100 index fund can unlock some significant advantages for an investment portfolio.
- Instant Diversification – By owning an index fund, an investor has indirectly bought shares in every company within the underlying index. Consequently, a portfolio is automatically diversified across multiple businesses, industries, and geographies.
- Volatility Hedge – The FTSE 100 contains exclusively large-cap stocks. These mature businesses are less susceptible to economic influences and rapid share price fluctuations. This can add some much-needed stability to an investment portfolio, especially during times of economic turmoil.
- Low Fees – Index tracker funds are almost always passively managed. Lower management fees come with a smaller expense ratio and, subsequently, deal less damage to total investment returns.
Disadvantages of investing in the FTSE 100
Despite the numerous advantages the FTSE 100 offers, there are several caveats to consider.
- Limited Growth – The FTSE 100 is a market capitalisation-weighted index. That means the largest companies have the most influence over the index’s performance. And the UK’s largest enterprises aren’t notorious for growth. With next to no exposure to mid-cap and small-cap stocks, returns from the FTSE 100 are largely driven by dividends which may provide insufficient growth for some investors.
- No Control – Index tracker funds do not have a stock selection criteria beyond a business being a constituent of the index that’s being tracked. As such, it’s possible for investors to indirectly own shares in companies that may not align with their ethical or moral values. For example, there are several tobacco stocks within the FTSE 100. However, there is no way to avoid these businesses when buying shares in an index fund.
Can I lose money by investing in the FTSE 100?
Yes. Every investment carries risk, even the largest and seemingly “safest” businesses on the London Stock Exchange.
Owning shares in a FTSE 100 index fund lets investors indirectly own a piece of every company within the index. However, should the earnings of these firms become compromised, it could lead to a decline in share price or result in dividends being cut. Should either of these events occur, it will adversely influence the performance of the FTSE 100 and, in turn, the investor’s investment.
Top 10 FTSE 100 stocks
Below are the top 10 FTSE 100 companies in order of market capitalisation as of 7 January 2023.
|8||British American Tobacco||BATS||£74.76bn|
Related: Complete list of all FTSE 100 stocks
Alternatives to the FTSE 100
There are several alternative indices for investors to choose from both in and out of the UK stock market.
- FTSE 250 – This stock market index tracks the performance of the 101st to the 250th largest UK stocks by market cap.
- FTSE 350 – It includes all the companies of the FTSE 100 index and FTSE 250 index
- FTSE AIM 100 – This index includes the largest 100 UK stocks by market capitalisation, which have their primary listing on the Alternative Investment Market (AIM).
- S&P 500 – This stock market index tracks the stocks of 500 large-cap US companies
- Dow Jones Industrial Average – This stock market index tracks the performance of the 30 largest and most prominent companies.
The bottom line
Investing in the FTSE 100 index is a simple yet proven investment strategy for long-term investors. Investment management tasks such as portfolio rebalancing are handled by a professional, automating a lot of the leg work. However, investing through an index fund also makes it impossible to outperform the stock market.
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This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.