It’s that time of year when we look back and reflect on the year that’s just gone. From a UK stock market perspective, despite all the negative headlines and geopolitical drama, 2019 turned out to be a pretty good year for investors.
Solid gains for the FTSE 100
The FTSE 100 rose by 12% over the course of the year, largely thanks to a late post-election rally in December, when the main index rose by 5% in less than four weeks. That said, the FTSE 100 still finished the year slightly below its peak, which came back in July.
The FTSE 100 is weighted towards the companies that have the highest market capitalisations. It’s also rebased at various times of the year, which involves the promotion and demotion of companies into and out of the index. In theory, this method should ensure that the FTSE 100 performs better than it otherwise would do, since falling stocks are removed and rising stocks are added.
Investing the same amount in all 100 stocks, that made up the FTSE 100 at the start of the year, would have generated a return of 18% (without dividends). Therefore, removing any weighting towards the biggest stocks would have beaten the market by 6 percentage points, supporting the idea that cheaper, smaller companies provide the greatest returns.
This average return is the one we would be most likely to get if we just picked a stock at random – which is not what I’m recommending. A median return of 19% shows that this average is not skewed by a few out-performers.
Some 76% of FTSE 100 constituents gained in value, while 61% managed to beat the FTSE 100s gain of 12%. This means that 24% lost value, with the average loss being 14%.
Meanwhile, half of the constituents registered gains of over 20%, with 15% returning more than 40%. At the other end of the spectrum, just 16% of stocks lost more than 10% during the year.
So what does this mean for investors?
On the face of it, this looks like it would be better to only invest in a few stocks to achieve higher returns. While it’s true that achieving a higher than average return is more likely when investing in a few stocks, it’s also more likely that a lower than average return will be achieved. Simply put, increasing the number of stocks – in other words diversifying – reduces investment risk.
To explain this further, if we invested equal amounts in four FTSE 100 companies at the start of the year, there would be a six percent chance that all stocks would have lost value. However, investing in all constituents would have reduced this chance to zero. Likewise, picking just one stock at random, would have had an almost 1-in-4 chance of losing value.
Personally, I am not comfortable taking on this amount of investment risk, which is why I make sure to diversify my holdings through the number of stocks that I invest in. But for best results, I’m not recommending that we all just buy index trackers. I believe that by researching individual stocks, we can identify those that are more likely to outperform the market and weed out the ones that are least likely to do well.