Question
Is the FTSE growth a myth?
We are continually told that equities outperform other investments in the longer term and various indexes such as the FTSE100 are quoted to back up the claim. But the make up of the FTSE100 is constantly changing with poorly performing shares dropping out and better performing shares coming in so it is hardly surprising that the index rises in the long term. What would be the value today of a proportionate basket of shares bought in Jan 1984? Quite a few of the constituent companies have gone bust and others have lost almost all of their share value so I find it hard to believe that the basket would have increased in value. In order to have made money one would have had to sell the weak shares and buy replacements so it comes down to stock picking (aka gambling) rather than investing in a medium that can be expected to do well in the long term.Answer
Had you bought the 100 companies that comprised the FTSE 100 Index in January 1984 and made no changes since then, I agree that some of those companies have probably since plunged and others will have soared. I’m afraid I don’t have access to the figures to know what the total return will have been.
You’re right that the FTSE 100 does review its constituents and weightings (quarterly), so it will obviously change over time. Is this the same as stock picking? Well I suppose it is, on the basis there’s a formula that determines which stocks are held and it what proportion. But the reason investors like to use the FTSE 100 as a benchmark (and for tracking) is that the investment selection is consistent, being formula-based.
However, the key point in all this is that the FTSE 100 Index is weighted. This means that if a large stock declines and eventually falls out of the Index it will have a big impact on the Index value. An extreme example: if a stock that accounts for 10% of the Index went of business tomorrow then the Index would fall by 10%. Weighting also means that the smaller stocks that enter or leave the Index each quarter tend to have minimal impact on the Index level.
Bearing all this in mind I’m not sure your argument holds. Shares dropping out of the FTSE 100 Index will, to varying degrees, have dragged the Index down while those entering might have a positive impact depending on their future share price performance.
It’s clear the FTSE 100 has grown longer term, especially when dividends are taken into account. And given many active fund managers find it difficult to consistently beat the Index; funds that track the FTSE 100 (or the FTSE All Share Index) are popular.
I think the gamble of index investing is that weighted indices tend to dominated by a handful of sectors. In the case of the FTSE 100, financial and oil/gas companies which account for 40% of the Index. This is an issue often overlooked by tracker investors.
Is the FTSE growth a myth?
We are continually told that equities outperform other investments in the longer term and various indexes such as the FTSE100 are quoted to back up the claim. But the make up of the FTSE100 is constantly changing with poorly performing shares dropping out and better performing shares coming in so it is hardly surprising that the index rises in the long term. What would be the value today of a proportionate basket of shares bought in Jan 1984? Quite a few of the constituent companies have gone bust and others have lost almost all of their share value so I find it hard to believe that the basket would have increased in value. In order to have made money one would have had to sell the weak shares and buy replacements so it comes down to stock picking (aka gambling) rather than investing in a medium that can be expected to do well in the long term.Answer
Had you bought the 100 companies that comprised the FTSE 100 Index in January 1984 and made no changes since then, I agree that some of those companies have probably since plunged and others will have soared. I’m afraid I don’t have access to the figures to know what the total return will have been.
You’re right that the FTSE 100 does review its constituents and weightings (quarterly), so it will obviously change over time. Is this the same as stock picking? Well I suppose it is, on the basis there’s a formula that determines which stocks are held and it what proportion. But the reason investors like to use the FTSE 100 as a benchmark (and for tracking) is that the investment selection is consistent, being formula-based.
However, the key point in all this is that the FTSE 100 Index is weighted. This means that if a large stock declines and eventually falls out of the Index it will have a big impact on the Index value. An extreme example: if a stock that accounts for 10% of the Index went of business tomorrow then the Index would fall by 10%. Weighting also means that the smaller stocks that enter or leave the Index each quarter tend to have minimal impact on the Index level.
Bearing all this in mind I’m not sure your argument holds. Shares dropping out of the FTSE 100 Index will, to varying degrees, have dragged the Index down while those entering might have a positive impact depending on their future share price performance.
It’s clear the FTSE 100 has grown longer term, especially when dividends are taken into account. And given many active fund managers find it difficult to consistently beat the Index; funds that track the FTSE 100 (or the FTSE All Share Index) are popular.
I think the gamble of index investing is that weighted indices tend to dominated by a handful of sectors. In the case of the FTSE 100, financial and oil/gas companies which account for 40% of the Index. This is an issue often overlooked by tracker investors.
Read this Q and A at http://www.candidmoney.com/questions/question169.aspx
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