It is early 2019, the FTSE 100 index isn’t far off yielding 5% and it is cheap by a whole host of value metrics. Not only is the index itself cheap in terms of value, but you can invest in a FTSE 100 index fund for peanuts too!
These trackers come with ongoing charges as low as 0.04%. Does it get any better than high dividend paying stocks dirt cheap?
Now has to be the time to buy………or does it?
There are many reasons why you could, but I think there are some more compelling reasons why you shouldn’t.
Let’s get into it.
Home bias
If you buy a fund tracking the the UK’s top 100 companies rather than a global index, you are basically betting against the wider market.
If you think you know something this wider market doesn’t then by all means go ahead, but it worth thinking about who the wider market is.
Last I looked, over 95% of trades are done by institutions i.e. pension funds, hedge funds, mutual funds, investment companies etc.
Just think about who you are up against! All those teams of highly experienced staff with degrees from the best universities, the latest software and equipment, and mountains of paid for information and data that individual investors simply don’t have access to.
Do you really feel confident betting against them?
Unless you want to gamble or you’ve really done some serious research and think you know something the market doesn’t, it has got to be safer to stick to a global index fund.
Market capitalization of the FTSE 100
Global index funds typically include different countries by market capitalization (market cap).
Market capitalization is calculated by multiplying the total number of shares of a company by that company’s share price.
For example a company with 10 million shares selling at $100 a share would have a market cap of $1 billion. Add up the companies from a particular country and you’ve got the market capitalization of that country.
So big companies take up a larger share of the market, and then countries with bigger companies take up a larger share of the world.
Exposure to a particular country will be equivalent to that country’s share of the world capital markets.
At the time of writing, the US currently makes up 54% of the world market, Japan is the next biggest with 8% and the UK is third with 5%.
As a result, a global fund would have over 54% in US stocks, 8% in Japanese stocks and 5% in UK stocks.
You can see the world according to market capitalization below. It is based on the FTSE All World Index, which is one of the most famous global indices out there.
What this means is any more than 5% invested in the UK market, even for a British investor is taking a decision against the wider market.
The market has decided how much you should have. Having more or less than 5% is an active bet and it’s a big call.
How much diversification is there?
On top of that, it is worth thinking about the number of companies in the the UK’s index compared to a global fund. The clue is in the name. The FTSE 100 contains ………. you guessed it – 100 companies, which sounds like a lot. But that compares to thousands in a global index fund.
And this brings us to one of the most important concepts in investing, diversification, which famed US writer and economist, Burton Malkiel describes as:
The only free lunch in investing.
Burton Malkiel
Diversification is a simple concept. Essentially, don’t put all your eggs in one basket.
Think about this. If you invest in one company and you choose badly and that company goes bankrupt you may lose all your money.
On the other hand, if you invested in 100 companies the chances of all of them going bankrupt are pretty low. Basically, the more companies you invest in the better and safer you will be.
I know what you’re thinking….. Wouldn’t it be better to just invest in all the good companies that are going to do well and skip all the bad companies?
Unfortunately, choosing which individual stocks are going to do well is an almost impossible mission for the average investor. In fact, most professionals seem to struggle with it too!
How to pick winning stocks – buy them all!
But there is one way to guarantee you’ll own all the best companies and that is to buy them all!
If you buy all of them you are guaranteed to own the ones that do well. Yes, you’ll also own some rubbish but the good companies will more than make up for it.
The more companies you invest in, the more diversified you will be. Diversifying your investments into as many companies as you can is a sensible decision. In fact, you don’t need to stop there. You can diversify into different business sectors and geographies.
Nobody knows what the future holds. The stock prices of individual companies crash all the time. Whole sectors go down from time to time and on occasion entire countries’ stock markets go down.
There’s a complete list all the FTSE100 companies at the end of this article, but at the time of writing, the biggest company, Shell makes up about 11%.
If it ran into hard times, it could put a dent in the entire index. Not long ago when BP had an oil spill in the Gulf of Mexico, the press was inundated with articles talking about the negative consequences on people’s pensions.
On the other hand, the biggest company in the FTSE All World index is Microsoft. It makes up just 1.84% of the index right now, so even if it went bankrupt it probably wouldn’t do too much damage to the wider index.
Another point to consider is sector concentration. The UK market is heavily focused in energy, consumer staples, and financials which is great when these areas do well, but not so great when they don’t.
On the other side of the coin, the technology sector has done great recently, but because the FTSE 100 index doesn’t contain many tech companies it hasn’t been able to take advantage of this.
Of course, that would be a good thing if tech did badly, but do you really think its advisable to be low on tech companies in this modern world?
UK stocks are cheaper than US stocks, but all those hedge funds know it too. If the UK really was a bargain, they’d have bought it and pushed the prices back up.
Market timing
On top of that, choosing one time to buy over another in the hope of getting a bargain is next to impossible. Even for the experts!
UK stocks may look good value right now, but that doesn’t mean we should buy them. Vanguard, the largest provider of mutual funds, says:
Research indicates that popular gauges such as growth rates, price-to-earnings ratios and profit margins offer virtually no guidance on equity prices over an annual period
Vanguard
And if that’s not enough, here’s a quote from the founder of Vanguard, John C.Bogle from his book Common Sense on Mutual Funds:
The idea that a bell rings to signal when investors should get into or out of the stock market is simply not credible. After nearly fifty years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently.
John C.Bogle – Common Sense on Mutual Funds
Is the UK a safe investment?
I have a friend who invests more or less exclusively in the UK. He splits his portfolio between UK stocks and UK gilts.
He gives the following reasons: He knows UK companies better, corporate governance is good, he doesn’t like any currency risk, many of the companies do most of their business overseas anyway, and passive index funds are dirt cheap.
Though I agree with his last two points, I can’t agree with the others.
UK company Knowledge
I’m sure he only thinks he knows the companies. He doesn’t really understand what financial situation they are in. Hedge funds, read the company reports, use financial models, meet with company management, and do a whole host of other things to get to know a company. Banking with HSBC doesn’t mean you know it.
Corporate governance
I have to agree that UK corporate governance is better than many places, but that doesn’t mean there aren’t plenty of other countries with good corporate governance. A good guide is the Index of Economic Freedom by the Heritage Foundation.
180 countries are ranked by economic freedom.
The following list is the top 10 countries on the FTSE All World Index with their economic freedom ranking.
For example, the UK is the has the 3rd biggest share of the FTSE All Share Index and is ranked 7 out of 180 countries for economic freedom.
- United States 12
- Japan 30
- UK 7
- China 100
- France 71
- Canada 8
- Switzerland 4
- Germany 24
- Australia 5
- Korea 29
The countries in the list take up 86% of the FTSE All World index and only China and France don’t score highly. In fact China and France together only take up about 7% of the index anyway, so 79% of a the FTSE All World index is composed of countries rated highly for economic freedom.
Currency risk
Currency risk should only be a concern over the short term. Over the long term, currency shouldn’t influence your investments.
But in any case, the companies in the FTSE 100 index do the bulk of their business overseas. The index is just about equally quartered in the UK, Americas, Europe and the rest of the world.
This means over 70% of business in carried out abroad, which is done in foreign currencies anyway!
Single country risk
In the end, I think my friend is taking a big risk by having everything in the UK. Stock markets can go down, and though they usually come back, a single country’s stock market might not.
At the time of writing the Chinese stock market is down nearly 60% from what it was prior to crashing just over a decade ago and the Japanese stock market is about 40% down from what it was before it crashed about 30 years ago. Crashes do happen and they can take a long time to recover.
It is also worth pointing out, that although the FTSE 100 has a dividend yield that looks good on paper it might not be suitable for everyone.
If your investments aren’t in a tax sheltered account you usually need to pay tax on your dividends. Even British expats that may not need to pay capital gains tax on their UK stock investments, usually have to pay tax on dividends.
Of course, if you want to take a punt on the fact that a Brexit outcome will mean the FTSE100 outperforming the wider stock market that’s your decision.
But just be aware that unless you know something everybody else doesn’t, you are going to be speculating rather than investing, and so it would be wise to only do it with money you are prepared to lose.
Complete list of companies from the FTSE 100 Index
| Company | Ticker | Sector |
| 3i | III | Financial Services |
| Admiral Group | ADM | Nonlife Insurance |
| Anglo American plc | AAL | Mining |
| Antofagasta | ANTO | Mining |
| Ashtead Group | AHT | Support Services |
| Associated British Foods | ABF | Food Producers |
| AstraZeneca | AZN | Pharmaceuticals & Biotechnology |
| Auto Trader Group | AUTO | Media |
| Aviva | AV | Life Insurance |
| BAE Systems | BA | Aerospace & Defence |
| Barclays | BARC | Banks |
| Barratt Developments | BDEV | Household Goods & Home Construction |
| Berkeley Group Holdings | BKG | Household Goods & Home Construction |
| BHP | BHP | Mining |
| BP | BP | Oil & Gas Producers |
| British American Tobacco | BATS | Tobacco |
| British Land | BLND | Real Estate Investment Trusts |
| BT Group | BT-A | Fixed Line Telecommunications |
| Bunzl | BNZL | Support Services |
| Burberry | BRBY | Personal Goods |
| Carnival Corporation & plc | CCL | Travel & Leisure |
| Centrica | CNA | Gas, Water & Multi-utilities |
| Coca-Cola HBC | CCH | Beverages |
| Compass Group | CPG | Support Services |
| CRH plc | CRH | Construction & Materials |
| Croda International | CRDA | Chemicals |
| DCC plc | DCC | Support Services |
| Diageo | DGE | Beverages |
| Direct Line Group | DLG | Non-life Insurance |
| easyJet | EZJ | Travel & Leisure |
| Evraz | EVR | Industrial Metals & Mining |
| Experian | EXPN | Support Services |
| Ferguson plc | FERG | Support Services |
| Fresnillo plc | FRES | Mining |
| GlaxoSmithKline | GSK | Pharmaceuticals & Biotechnology |
| Glencore | GLEN | Mining |
| Halma | HLMA | Electronic & Electrical Equipment |
| Hargreaves Lansdown | HL | Financial Services |
| Hikma Pharmaceuticals | HIK | Pharmaceuticals & Biotechnology |
| Hiscox | HSX | Nonlife Insurance |
| HSBC | HSBA | Banks |
| Imperial Brands | IMB | Tobacco |
| Informa | INF | Media |
| InterContinental Hotels Group | IHG | Travel & Leisure |
| International Airlines Group | IAG | Travel & Leisure |
| Intertek | ITRK | Support Services |
| ITV plc | ITV | Media |
| Johnson Matthey | JMAT | Chemicals |
| Just Eat | JE | Food and Drink |
| Kingfisher plc | KGF | General Retailers |
| Land Securities | LAND | Real Estate Investment Trusts |
| Legal & General | LGEN | Life Insurance |
| Lloyds Banking Group | LLOY | Banks |
| London Stock Exchange Group | LSE | Financial Services |
| Marks & Spencer | MKS | General Retailers |
| Melrose Industries | MRO | Automobiles & Parts |
| Micro Focus | MCRO | Software & Computer Services |
| Mondi | MNDI | Forestry & Paper |
| Morrisons | MRW | Food & Drug Retailers |
| National Grid plc | NG | Gas, Water & Multi-utilities |
| Next plc | NXT | General Retailers |
| NMC Health | NMC | Health Care Equipment & Services |
| Ocado | OCDO | Food & Drug Retailers |
| Paddy Power Betfair | PPB | Travel & Leisure |
| Pearson plc | PSON | Media |
| Persimmon plc | PSN | Household Goods & Home Construction |
| Phoenix Group | PHNX | Life Insurance |
| Prudential plc | PRU | Life Insurance |
| Reckitt Benckiser | RB | Household Goods & Home Construction |
| RELX | REL | Media |
| Rentokil Initial | RTO | Support Services |
| Rio Tinto Group | RIO | Mining |
| Rightmove | RMV | Media |
| Rolls-Royce Holdings | RR | Aerospace & Defence |
| Royal Bank of Scotland Group | RBS | Banks |
| Royal Dutch Shell | RDSA | Oil & Gas Producers |
| RSA Insurance Group | RSA | Nonlife Insurance |
| Sage Group | SGE | Software & Computer Services |
| Sainsbury’s | SBRY | Food & Drug Retailers |
| Schroders | SDR | Financial Services |
| Scottish Mortgage Investment Trust | SMT | Equity Investment Instruments |
| Segro | SGRO | Real Estate Investment Trusts |
| Severn Trent | SVT | Gas, Water & Multi-utilities |
| Smith & Nephew | SN | Health Care Equipment & Services |
| Smith, D.S. | SMDS | General Industrials |
| Smiths Group | SMIN | General Industrials |
| Smurfit Kappa | SKG | General Industrials |
| Spirax-Sarco Engineering | SPX | Industrial Engineering |
| SSE plc | SSE | Electricity |
| Standard Chartered | STAN | Banks |
| Standard Life Aberdeen | SLA | Financial Services |
| St. James’s Place plc | STJ | Life Insurance |
| Taylor Wimpey | TW | Household Goods & Home Construction |
| Tesco | TSCO | Food & Drug Retailers |
| TUI Group | TUI | Travel & Leisure |
| Unilever | ULVR | Personal Goods |
| United Utilities | UU | Gas, Water & Multi-utilities |
| Vodafone Group | VOD | Mobile Telecommunications |
| Whitbread | WTB | Retail hospitality |
| WPP plc | WPP | Media |