How To Invest In The FTSE 100 Index – Forbes Advisor UK

The FTSE 100 index comprises the largest 100 companies listed on the London Stock Exchange by market capitalisation.

Stock market indices are an important part of the investing landscape. They are essentially barometers that provide stocks and shares – or equities – investors with an indication of how the markets are behaving in general, as well as how individual companies are performing.

The FTSE 100 is one of the world’s most famous stock market indices. Here’s a look at how it works, along with ways to invest in the index.

What is a stock market index?

A stock index provides a standardised way of tracking changes in the price of an overall basket of shares or other assets.

This allows investors to see how a particular stock market performs day-to-day (and year-to-year) and to gauge how the performance of different markets compare with one another.

Indices also enable investors to see how a particular company’s shares are performing against, say, a peer group of similar businesses – for example, technology, energy, or financial.

Most indices are weighted by the size, or market capitalisation, of the individual constituent companies. The market cap is calculated by multiplying the current share price of a company by the total number of shares in issue. As a result, a company with a market cap of £10 billion has double the weighting of a company worth £5 billion.

Once each company within an index has been suitably weighted, the combined market cap of all the shares is calculated on a daily basis. This enables a valuation of the overall index to be made and allows investors to see how its performance changes, both up and down, over time.  

Why are indices useful?

Indices provide a snapshot of the performance of a market sector, without having to analyse the performance of the individual companies within it.

Indices are also an important tool for assessing the performance of investments as actively-managed funds aim to ‘beat the benchmark’ which is usually based on a specific index.

In addition, indices are central to the working of so-called ‘passively-managed’ funds, also referred to as ‘index’ or ‘tracker’ funds. Tracker funds try to replicate the performance of an index and have become increasingly popular among investors for their low costs in recent years.

What is the FTSE 100?

The UK’s best-known index is the Financial Times Stock Exchange (FTSE) 100, which comprises the hundred largest companies listed on the main market of the London Stock Exchange by market cap. The index is also referred to as the ‘Footsie’.

At the time of writing (August 2023), AstraZeneca is currently the largest company in the FTSE 100, with a market cap of £165 billion while Johnson Matthey is the smallest, valued at £4 billion.

The Footsie also features a high proportion of companies from the financial, commodity, oil & gas and pharmaceutical sectors including the likes of BP, HSBC, Barclays, Glencore and AstraZeneca. You can find a full list of Footsie constituents here.

According to FTSE Russell, the company that runs the Footsie (see below), around 80% of the revenues generated by Footsie companies is generated from overseas markets. This means that the FTSE 100 is less dependent on the UK economy than, say, the FTSE 250, another UK index (see below) which generates just 60% of its revenues from abroad.

How does the FTSE 100 index work?

The FTSE 100 index is maintained by FTSE Russell and is reviewed every quarter. This enables companies to qualify for a ‘higher index’ if their market cap rises sufficiently to meet the threshold.

Companies tend to benefit from a boost to their share price if they qualify for a higher index, as tracker funds will buy shares to replicate the index. However, the reverse is also true, with companies facing further downward pressure on their share price if they are moved to a lower index.

The market cap threshold is set at a level to limit the number of changes to the index due to the potential impact on a company’s share price from being added or removed. As a result, a company is required to have a market cap putting it at least 90th in the index, to be promoted, or below 111th to be removed.

As the FTSE 100 index is weighted by market cap, the share prices of the largest companies have a significant impact on the overall index. The top five companies, Shell, AstraZeneca, Unilever, HSBC and BP, currently account for a third of the FTSE 100 index as a whole. 

As a comparison, the Nasdaq 100 in the US is even more concentrated with the five largest companies accounting for over 40% of the overall index, while the top two Apple and Microsoft, represent a quarter of the overall index.

Thanks to the presence of plenty of ‘old economy’ stocks, for example, the likes of mining and pharmaceutical companies, the FTSE 100 held up relatively well despite the downturn in global stock markets last year.

However, the FTSE 100 has underperformed its US counterpart this year, falling by 4% compared to a 20% rise in the S&P 100. The FTSE hit an all-time high of more than 8,000 in February but has been weighed down by high inflation and rising interest rates in the UK.

What are the other FTSE indices?

Although the FTSE 100 is the most well-known index, there are a number of other FTSE indices in the family, including:

• FTSE 250 – the 250 ‘next largest’ companies by market cap
• FTSE 350 – the FTSE 100 and 250 combined
• FTSE Small Cap – the 350th to 600th largest companies by market cap.
• FTSE All Share – the FTSE 100, 250 and Small Cap indices combined

These indices provide an opportunity to invest in different types of companies, from the mid-cap companies making up the FTSE 250 to some of the more speculative companies in the FTSE Small Cap. 

The returns of these indices are as follows:

Generally speaking, larger-cap stocks tend to be more resilient in a stock market downturn as they have the financial firepower to weather more challenging economic conditions. However, small-cap companies may deliver higher growth in times of economic boom.

How can you invest in the FTSE 100 index?

Passively-managed funds provide the simplest way of investing in the FTSE 100 index. They pool money from investors and invest it in a basket of constituent companies or assets to replicate the index.

There are two main types of tracker funds:

• Open-ended investment companies (OEICs): these either track the index directly, or may invest in a sub-set of the index, for example, UK large-cap shares. Unlike ETFs (see below), they are ‘forward priced’ meaning that they are repriced once per day and investors won’t know the execution price until after the trade.
• Exchange-traded funds (ETFs): these are one of the most common ways of investing in a tracker-fund. Like OIECs, they aim to replicate an index but they have a ‘live’ price meaning that investors know the execution price when they place the trade.

There are two different methods used by tracker funds to replicate an index. The first is ‘full replication’ where the tracker fund buys shares in each of the companies in the FTSE 100 index in proportion to its weighting.

Alternatively, tracker funds may opt for ‘partial replication’ where they hold a representative sample of companies to replicate the index, rather than every company. Partial replication is typically used when there is a high number of companies in an index or where the companies are less ‘liquid’, in other words, it’s harder to buy and sell shares.

The average annual management fee for a tracker fund is around 0.05% to 0.20%, compared to 0.5% to 1.0% for an actively-managed fund. Using the lower of each pair of figures, this means that a £1,000 investment in a tracker would typically cost £5, compared with £50 for an active fund.

Investors may also have to pay a transaction fee on buying or selling a tracker fund, in addition to an annual platform fee for holding the fund. It’s worth reviewing our pick of the best trading platforms as fees can vary significantly between providers.

Tracker funds can also be bought within a tax-efficient wrapper such as an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP) which are free from capital gains and income tax. We’ve compiled our pick of the best ISA providers and SIPP providers to help with this.