How to invest in the FTSE 100

FTSE 100 investing: what you need to know

The FTSE 100 – an index of the UK’s largest 100 public companies by market capitalisation – has become a popular way to gain exposure to the UK stock market and track the performance of the country’s economic health.

The market capitalisation of the index has grown sixfold since its inception in 1984, as its constituents have experienced success and growth.

As a stock index is simply a number that represents a group of shares on an exchange – in this case the London Stock Exchange (LSE) – you cannot invest in it directly. An alternative means of exposure is investing in the shares of FTSE 100 companies or in exchange traded funds (ETFs). But for those who want to gain exposure to the index itself, there is another way: indices trading.

Read on to take a look at these two routes to the financial markets and decide which one is best for you.

Ways to invest in the FTSE 100

Investing in the FTSE 100 can be an appealing option for those looking to diversify their exposure, as ‘the footsie’ is made up of a vast range of sectors. It is thought to reduce risk because a fall in one industry is often offset by a rise to another.

When investing in the index, you could choose to focus on a handful of companies, or you could spread your investment out across all the constituents by using a FTSE 100 ETF.

Invest in FTSE 100 stocks

The companies that have made it onto the list of FTSE 100 constituents are selected based on rigorous criteria, which include the company’s market capitalisation, liquidity and nationality. Although changes to the FTSE 100 constituents do happen, they are not that regular. This means that stocks on the index are often thought likely to stand the test of time.

When you invest in FTSE 100 stocks, you buy the shares of the companies at face value, in the hopes that they will increase in value and you can sell them later for a profit. When you buy shares outright, you gain shareholder privileges such as voting rights and dividend payments.

FTSE 100 stocks are popular among investors partly because of the healthy dividends that they pay, with an average dividend yield of 4.4%.¹ This has helped the companies keep the confidence of their shareholders.

If we take a look at the five-year returns – the money shareholders would see if they reinvested their dividends every year for five years – some of the top companies on the FTSE 100 include:

• Royal Dutch Shell (RDS): despite crises in the oil market, shares of the oil giant have continued to rise and averaged a five-year return of 50%
• HSBC Holdings (HSBA): in 2018, HSBC was the second largest company on the FTSE 100. Its successes meant that its shareholders saw similar returns to those of Shell
• British American Tobacco (BATS): shareholders of the multinational business saw five-year returns of nearly 70%
• Unilever (ULVR): another popular choice among FTSE 100 investors, the company gave its shareholders five-year returns of around 80%

The shares of FTSE 100 companies are generally very liquid, which provides investors with greater flexibility when opening and closing their positions.

Invest in FTSE 100 ETFs

Exchange traded funds (ETFs) are assets that are bought and sold on stock exchanges, like shares, but are made up of a range of assets instead – often called a ‘bucket’. They are designed to track the performance of an underlying benchmark such as the FTSE 100.

When you invest in the FTSE 100, you are essentially spreading your capital out across the top 100 companies in the UK, which makes it important to consider exactly how your money is being distributed.

The most common form of FTSE 100 ETF is a weighted tracker, which mirrors the make-up of the FTSE 100 directly. The FTSE 100 is a weighted index, which means that your portfolio would hold each stock in the same proportion as its weighting on the index. A large portion of the FTSE 100 is made up of just 12 companies, so it could be restricting to investors that want a broader exposure. Examples of weighted trackers include the Vanguard FTSE 100 UCTIS ETF and the iShares Core FTSE 100 UCITS ETF.

But there are a variety of other types of FTSE 100 ETFs that you can choose from depending on your personal preferences, including:

• Equal distribution trackers: a type of smart ETF that splits your investment equally across all of the constituents of the FTSE 100. An example is the Xtrackers FTSE 100 Equal Weight UCITS ETF
• Fundamentals weighted trackers: this form of smart ETF takes into account the fundamentals of the company, including its sales, dividend payments and cashflows. The ETF is then weighted based on the companies that have the highest fundamentals. An example is the PowerShares FTSE RAFI UK 100 UCITS ETF

Ways to trade the FTSE 100

When you invest in the FTSE 100, you are taking a long-term view on its performance, assuming that it will rise in value over time. However, trading the FTSE 100 gives you the opportunity to take advantage of the index falling in value as well as rising. You can trade the FTSE 100 index, FTSE 100 stocks and FTSE 100 ETFs by using derivative products such as futures and CFDs.

When you invest, you are required to put down the full value of an asset upfront, but when you use derivative products you can trade them using leverage. Leveraged products enable you to gain full market exposure by only putting down a fraction of the capital required – known as margin.

Using leverage creates the possibility of magnified profits, because the gains to your position are calculated using the full value of the trade. However, leverage also comes with increased risk, as losses are also calculated using the full value, which creates the potential for magnified losses.

If you decide to trade the FTSE 100, it’s important to create a risk management strategy, which should include stops to limit your losses if the market moves against you.

Trade FTSE 100 futures contracts

As there are no physical assets to deal, there is no way to invest in the FTSE 100 itself. But derivative products do not depend upon ownership of a physical asset, instead they take their price from the underlying market.

Most stock indices trading involves trading futures contracts, which are an agreement to trade at a specific price on a specific date. You can trade index futures themselves, or you can trade CFDs on their price.

When you open a position to trade CFDs, you are speculating on the future price of the FTSE 100. If you believe that it is going to rise in price, you would open a position to buy the index, and if you believe it is going to fall in price, you would open a position to sell it instead.

Trade FTSE 100 stocks and ETFs

Alternatively, you still have the option to trade the constituent shares of the FTSE 100 or FTSE 100 ETFs.

When you invest in shares, you are aiming to buy low and sell high. When you trade shares, you can take both this traditional long view, or you can sell high and buy low, known as short-selling or going short.

Learn more about how to short a stock.

When you trade FTSE 100 ETFs, you have the flexibility to take a shorter-term view on the performance of the index benchmark, and a short position if you think that the index’s price is heading down.

Whether you decide to trade or invest in the FTSE 100, it is important to make sure that you have created an appropriate strategy and decide how you are going to manage your risk.

Learn how to build a trading plan and manage your risk with IG Academy’s range of online courses.

¹Dividend Data, 2018