Getting Started With Trackers

Published in Investing on 25 October 2010

New investors should look beyond the FTSE 100.

If you're just getting started in investing, an index tracker makes good sense. It gives you exposure to a broad selection of stocks at lower risk and cost than investing in a few individual companies or an expensive actively managed fund.

You'll probably want to stick close to home to begin with, and choose a UK tracker.

Which index?

There are four main indices in the UK:

  • FTSE 100 -- the largest 100 companies;

  • FTSE 250 -- the companies ranked 101 to 350;

  • FTSE Small Cap -- about 280 smaller listed companies; and

  • FTSE All-Share -- the aggregation of the FTSE 100, FTSE 250 and FTSE SmallCap indices.

FTSE 100 trackers are very popular, as are All-Share trackers. There are a few FTSE 250 trackers on the market, too, but no Small Cap tracker.

Because the individual companies in the indices are weighted proportionally by size, there is less difference than you might imagine between a FTSE 100 and All-Share tracker.

The FTSE 100 represents over 80% of the All-Share and dominates its performance. The FTSE 250, accounting for 15%, makes a relatively small contribution, whilst the contribution of the Small Cap, which represents as little as 2%, is negligible.

FTSE 100

As the table below shows, the 10 biggest companies in the FTSE 100 represent nearly half of the index:

CompanyIndex weight
%
Royal Dutch Shell (LSE: RDSB)8.3
HSBC (LSE: HSBA)7.9
Vodafone (LSE: VOD)5.9
BP (LSE: BP)5.5
GlaxoSmithKline (LSE: GSK)4.5
Rio Tinto (LSE: RIO)4.2
Lloyds Banking (LSE: LLOY)3.3
British American Tobacco (LSE: BATS)3.3
BHP Billiton (LSE: BLT)3.3
AstraZeneca (LSE: AZN)3.2
Total49.4

The top company, Shell, is more than 50 times bigger than the company ranked 100.

A FTSE All-Share tracker reduces the concentration of the biggest companies, but not by a great deal: the top 10 account for nearly 40% of the All-Share.

FTSE 250

In the FTSE 250 the weightings are more balanced. As the table below shows, the 10 biggest companies represent just over 10% of the index:

CompanyIndex weight
%
IMI (LSE: IMI)1.2
ITV (LSE: ITV)1.2
Informa (LSE: INF)1.1
SSL International (LSE: SSL)1.1
Tate & Lyle (LSE: TATE)1.1
Pennon (LSE: PNN)1.0
Segro (LSE: SGRO)1.0
Templeton Emerging Markets (LSE: TEM)1.0
Meggitt (LSE: MGGT)1.0
Babcock International (LSE: BAB)0.9
Total10.6

The difference in size between the biggest and smallest companies in the FTSE 250 is also significantly less than in the FTSE 100.

The companies at the lower end of the FTSE 250 are no obscure tiddlers. Worth £300m+, they include such names as Yellow Pages directories firm Yell (LSE: YELL), retail chain JD Sports (LSE: JD), and comparison website Moneysupermarket.com (LSE: MONY).

Don't ignore the FTSE 250

FTSE 250 trackers are less popular with new investors, and there are fewer products on the market, but there are two very good reasons for holding such a tracker alongside either a FTSE 100 or All-Share tracker.

First, FTSE 250 firms have more scope for growth than the elephantine companies of the top index. Historically, the FTSE 250 has outperformed the FTSE 100 over the long term, although for short spells the FTSE 100 has done better.

Second, holding a FTSE 250 tracker as well as a FTSE 100 or All-Share tracker improves the overall balance of the individual companies, reducing your reliance on the performance of just a few very large firms.

Split for growth

A simple 50/50 split between FTSE 100/250 trackers (or 55:45 FTSE All-Share/250 split for a similar result) gives you meaningful exposure to the higher growth potential of the FTSE 250.

Such a split also dilutes the dangerous concentration in the biggest firms by reducing the contribution of top company Shell from 8% to 4%, and likewise halving the whopping 50% contribution of the top 10.

In short, whilst FTSE 100 and All-Share trackers are heavily marketed, it's well worth considering blending one of them with a FTSE 250 tracker.

In for the long term

In the short term markets can be volatile and you need to be prepared to see the value of your investment fall at times -- and, on occasions, quite alarmingly.

As legendary investor Warren Buffett has put it: "Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."

In the long term, though, equities have the potential for superior returns to cash and other asset classes, such as bonds. The longer your investment horizon the better.

Even in the Noughties, the so-called 'Lost Decade For Shares', a young investor regularly feeding money into trackers would be well on course for achieving long-term capital growth.

More from G A Chester:

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Luniversal 25 Oct 2010 , 10:41am

As legendary investor Warren Buffett has put it: "Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."

And as he also said, Rules One and Two of investing are never to lose money.

Too many cooks make light work, many hands spoil the broth, and we get far too much of the Sage of Omaha's cornpone vapidities on this site. He's better studied than heard.

Otherwise, good thinking, M0by. What's the cheapest FTSE 250 tracker without too much tracking error?

MunroMan 25 Oct 2010 , 11:36am

There is no evidence to suggest that the 250 has more growth potential than the 100.

The only thing we know is that the 250 is more expensive than the 100.

On mkt caps the split would be 90:10. We know Value Investing works. Therefore a portfolio should be biased towards the 100, something like 95:5. There is no argument to justify a 50:50 split.

compound200 25 Oct 2010 , 1:18pm

wanting too invest regular savings isa--in F&C global smaller companies(fcs)

whats cheapest way to do it?

thx

diddyda 25 Oct 2010 , 3:34pm

Luniversal: To my knowledge the lowest cost 250 tracker is HSBC 250 Index Retail (either in the ACC or INC version). It has a total expense ratio (TER) of only 0.27%. Most others seem to be in the order of 1.5% TER.

I personally use TD Waterhouse brokerage as there is no other charges levied for investing provided you have more the £3,000 in your account.

Regular investing each month also gives the advantage of pound cost averaging, which takes the guesswork out of timing the market.

M0byDick 26 Oct 2010 , 10:00am

Interesting comments.

Malcolm Wheatley did a round-up of FTSE 250 products back in April (some of the numbers may have changed since) http://www.fool.co.uk/news/investing/investing-strategy/2010/04/22/how-to-track-mid-caps.aspx.

Luniversal: the HSBC 250 tracker mentioned by diddyda has a tracking error of around 0.5/0.6% from memory.

Lord Essex: the FTSE 250 has outperformed in the past: see the graph in the following (pdf) document from FTSE.com http://www.ftse.com/Indices/UK_Indices/Downloads/FTSE_250_Index_Factsheet.pdf.

compound200: the F&C Global Smaller Companies is an investment trust and buying shares in it is no different to buying shares in any other listed company: if you're unfamiliar with investment trusts, you can learn more about them in this article: http://www.fool.co.uk/news/investing/2010/01/27/why-investment-trusts-are-foolish.aspx.

Foolish best,
MobyD (G A Chester)

Investa69 26 Oct 2010 , 1:23pm

any chance of the Fool offering trackers via www.foolsharedealing.co.uk any time soon? It would make life soo much easier for us and of course you'd get more commission!! :)

Afrosia 26 Oct 2010 , 1:31pm

I'm probably wrong, but surely buying a FTSE 250 tracker for growth wouldn't work because the companies would grow and then leave the index? Surely you want to spot a basket of companies and hold them through the FTSE 250 and beyond?

Luniversal 26 Oct 2010 , 4:36pm

Thanks to diddyda and M0by for advice.

Afrosia-- Good point. You could call it "promotionship depression".

How much turnover pa is there between the 100 and the 250 anyway? Don't a clutch of companies habitually do a stately minuet, dancing in and out of each league as their fortunes fluctuate, like West Brom? (TATE comes to mind.)

You could go crazy worrying about these minutiae.

NikThomas 28 Oct 2010 , 1:13pm

@mobydick:
Note that the URL for the Unit Trusts advice includes an extra '.' that leads to a 404 error. Link should be to
http://www.fool.co.uk/news/investing/2010/01/27/why-investment-trusts-are-foolish.aspx

beastofbodmin 30 Nov 2010 , 8:03pm

And another article promulgating the usual useless crap about how to invest. Yet without looking at historical values.

As usual no advice about when to get in and when to get out.

Holding for the long term, come hell or high water, is simply to give money to the fund managers.

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