What are the average returns of the FTSE 100?

What is the FTSE 100?

The FTSE 100 is an index that represents the top 100 companies on the London Stock Exchange (LSE) by market capitalisation. It was created on 3 January 1984, with a starting value of 1000.

A market-capitalisation weighted index is an index construction methodology where companies are weighted according to their total market capitalisation.

To qualify for inclusion on the FTSE 100, all companies must have a full listing on the LSE, be denominated in sterling and meet minimum criteria for both market capitalisation and liquidity.

Companies with a higher market capitalisation will carry greater weight in the index, and changes in their share prices will influence the movement in the index more.

For example, Shell, with a market capitalisation of almost £190 billion (as of 31 March 2023), will have a greater influence on the FTSE 100 price level than Pearson, which has a market cap of £6.1 billion.

How can you measure the performance of the FTSE 100?

You can look at the performance of the FTSE 100 in terms of price and total returns. The difference between the two is that total returns include reinvested dividends paid to shareholders, while price returns exclude them. Figure 2 highlights the difference between the two measures since the inception of the FTSE 100.

From 1984 to 2022, the price return was 645.2%, yet the total return of the index was over double at 1514.92%. On an annualised basis, this equates to a price return of 5.4%, and a total return of 7.48%.

To annualise an investment return, we can perform the following calculation:

(1 + period return %) ^ (1 / number of periods) – 1 = annualised return

(1 + 15.1492) ^ (1 / 39) - 1 = 7.4%

How can you measure dividend reinvestments and nominal returns?

When you isolate an individual dividend payment, it may seem rather insignificant to total returns. Yet, as the dividends accumulate, there’ll be a substantial impact on the total return due to the compounding effect.

This is where cash dividends are reinvested, and your total holding increases. With larger holdings, you’ll start to earn more dividends. Effectively, further interest is earned on interest accrued. As time goes, on the power of compounding starts to make a significantly positive impact on the value of your portfolio.

From 31 December 2012 to 31 December 2022, the price return of the FTSE 100 was just over 23%. Yet, if dividends were reinvested when applicable, the return was over 84%.

To contextualise this, if you had invested £10,000 in December 2012, the value of your initial investment after ten years would be around £12,600, based on just index movements, equating to a £2600 gain.

However, if you invested £10,000 in December 2012 and reinvested dividends, then the value of your initial investment would be over £18,500 by December 2022. Hence, by reinvesting dividends, you could’ve made almost £6000 on top of the standard return of the index. This illustrates the profound and influential impact of compounding over time.

The chart below further shows the impact of dividend investing. While the extra gain from reinvested dividends is barely noticeable at the start, as time progresses, the return profile of an investment with and without reinvested dividends is night and day.

FTSE 100 price return vs total return over a decade

What’s the difference between nominal and real returns?

A real return is the ROI where inflation has been taken into account, while a nominal return hasn't.

This means an investments performance should often be evaluated based on real returns to accurately detail how much an investment has truly returned, based on the price level of an economy and the change in investment value. The formula to calculate the real return should be as follows:

Real return % = nominal return % – inflation rate%

Assuming the inflation rate is positive, nominal returns will always be greater than real returns. However, the higher the rate of inflation, the faster the value of your money is eroded. This will have a negative effect on your overall spending as inflation chips away at what your cash value can afford.

That’s why investing your money tends to be a more constructive use of your capital compared to placing it under the mattress, where no growth can occur. You can invest in inflation-beating assets to protect your money.

On average, the FTSE 100 has outperformed inflation. Over the last 119 years, UK stocks have made annualised returns of +4.9% over and above inflation. Therefore, if you think inflation will be 2.5% on an ongoing basis, you might expect your long-term returns to be around 7.5%.

This signifies that an equity investment such as investing in the FTSE 100 index would’ve generated an inflation-beating return for investors over a period spanning almost 40 years.

However, it’s important to remember that past performance is no indicator of future returns, and there’s always a risk you could lose more than you put in when investing.

What impacts the performance of the FTSE 100?

Most of the firms who constitute the FTSE 100 index have an international presence. This means that there’s a wide range of factors that can influence performance. Some of the key factor include:

• Currency fluctuations – 80% of the FTSE 100 companies’ revenue is generated from overseas, a large proportion of this is generated in US dollars. Hence, a depreciation in sterling relative to other currencies means profits are boosted when converted back into sterling. This can help contribute to a rise in the FTSE 100 index. In 2022, this played a role in the FTSE 100’s relative outperformance to international indices
• Monetary policy – higher interest rates are likely to have a negative impact on the price of the FTSE 100. In December 2021, the Bank of England’s (BOE) base rate was 0.25%. It currently stands at 4%, with further rate hikes expected. When interest rates rise, it increases borrowing costs for firms, which can squeeze profit margins. On the other hand, higher interest rates may boost profits of financials that constitute the FTSE 100, such as NatWest
• Company earnings – publicly traded companies have an obligation to report performance. In most cases, when a companies’ earnings exceed analyst’s expectations, we see an appreciation in share price. For example, Shell’s 2022 earnings were above estimates and the share price has performed strongly as a result
• Oil and commodity prices – some of the largest constituents of the FTSE 100 are oil and commodity companies. A rise in the price of oil and other commodities will likely lead to a rise in the share price of oil companies and other commodity producers, such as Glencore. Both Shell and BP are in the top five largest companies listed on the FTSE 100 based on market capitalisation. Their strong 2022 helped aid the FTSE 100s relative 2022 outperformance to global equity indices
• UK sentiment – bullish or bearish general sentiment towards a listed company can influence the returns of the FTSE 100. Most notably Brexit provided immensely sour sentiment towards the UK. The four years after the Brexit referendum were characterised by weak FTSE 100 performance. Investors would’ve generated a stronger return if they had invested in US equities. Even investing in emerging markets, where nations are no stranger to political instability and debt defaults would’ve provided better returns

Post Brexit equity indices returns (GBP)

What has been the range of returns for the FTSE 100?

Equity markets will generally move in the same direction as economic activity. Falling in value before an economy enters into recession and rising before the economic recovery begins. The chart below shows the range of annual returns for the FTSE 100 over the last 35 years.

FTSE 100 Calendar Year Returns

What are the largest drawdowns for the FTSE 100?

While the average annual price return for the FTSE 100 was 6.8% since 1984, investors should be prepared for a range of potential annual returns. The largest annual price return was 35.1% in 1989, while the lowest was -31.3% in 2008.

However, this doesn’t reflect intra-year price movements. To capture the largest drops an investor may face, or what is known as a ‘drawdown’, we looked at daily price data for the FTSE 100 going back to its inception.

What has been the maximum drawdown of the FTSE 100?

The largest peak-to-trough decline was 52.6% in March 2003. A number of events put downward pressure on UK stocks during this bear market. The collapse of the dotcom bubble brought about massive declines in the share price of many FTSE 100 companies.

FTSE 100 max drawdowns

Telecoms behemoth BT Group’s share price fell by over 85% from its previous peak. Investor confidence in global stock markets was also hindered by the 9/11 terrorist attack. It wasn’t until the start of the Iraq War that the FTSE 100 index reached a bottom at 3287 in March 2003.

Other notable declines occurred during the Great Financial Crisis of 2007 to 2008. In 1987 following Black Monday, investor panic and computer-driven trading models followed portfolio insurance strategies that precipitated the crash.

This analysis shows that, while these sudden market crashes are rare in nature, investors should reasonably expect the stock market to decline by more than -30% every ten years.

Falls of this scale can certainly be concerning, but selling an investment to mitigate further losses is often a poor strategy.

The table above shows that the FTSE 100 recovered a large part of its losses over the following 12 months after the index reached a trough. It’s important to note, though, that a +40% rise after a 53% decline does not leave you 13% down, but still 34% down. A 50% drop requires your investment to rise by 100% to break even on your initial investment.

Best and worst FTSE 100 returns for different holding periods

Investing over a longer timeframe helps to reduce your chances of realising a loss on your investment. This can be shown by looking at different holding periods and taking the lowest annualised return for each time horizon.

The worst two-year return since the FTSE 100 was created was -33%, or -18% on an annualised basis, between 31 December 2000 and 31 December 2002. The worst five-year annualised return was -4% per year, between 31 December 1999 and 31 December 2004.

Since the FTSE 100’s inception in 1983, there’s never been a ten-year holding period where the investor lost money. The worst ten-year annualised return was +0.3%, between 31 December 1999 and 31 December 2008.

What’s also very apparent is that the starting point at which an investor makes their initial investment has a large impact on their long-run average return. An investor who bought the FTSE 100 in 1989 would’ve been rewarded with an annual average return of 18% over the following ten years, compared to a 0.3% annual average if they had bought in 1998 and sold at the end of 2008.

Timing markets is notoriously difficult – even seasoned investors struggle with this. Many investors engage in pound cost averaging to ensure that they don’t unintentionally invest the bulk of their savings at a market peak and at a high average cost.

How can you get exposure to the FTSE 100?

Through our share dealing account, you can purchase an ETF, which tracks the performance of the FTSE 100 and you can earn dividends. The dividends can be reinvested or paid as income depending on personal preference. This is an option typically used by longer-term investors. iShares Core FTSE 100 UCITS ETF (CUKX) is a popular choice for investors.