Most investors should forget about individual stocks and invest into a diversified index, like the FTSE 100. That’s Warren Buffett’s advice.
According to Buffett, figuring out which businesses are going to outperform an index is too difficult for 99% of investors. As such, they should just buy the entire index.
I’m a big admirer of Buffett. But in the case of the FTSE 100, I don’t think that buying the index is a good idea for my portfolio.
As a whole, I find the FTSE 100 somewhat uninspiring. But hidden in the underwhelming index are some stocks that I think are really interesting investment propositions.
The index
To say that the FTSE 100 has been disappointing over the last five years is to put it mildly. The index is currently around 1% lower than it was in August 2017.
This doesn’t mean that someone who invested in the FTSE 100 five years ago would have lost money. By itself, the level of the index doesn’t factor in dividends that an investor would have received.
Including dividends, the FTSE 100 has provided investors with a 21.5% return over the last five years. So a £1,000 investment in the FTSE 100 five years ago would be worth just under £1,250 today.
With inflation at around 9%, an investment that returns around 4% per year doesn’t look that exciting. So following Buffett’s advice and buying the index in the case of the FTSE 100 seems unattractive.
FTSE 100 stocks
While the index has been uninspiring as a whole, there are some stocks within that have produced outstanding returns for shareholders. Experian (LSE:EXPN) is a good example.
Over the last five years, the Experian share price has increased by around 91%. A £1,000 investment in Experian would therefore be worth at least £1,910 today.
In addition, an Experian shareholder would have received dividends over the last five years. These would have totalled around £126.
An investment in Experian shares would therefore have returned around four times the FTSE 100. That’s why I own Experian shares in my portfolio.
It’s not just Experian, either. Other stocks, including Halma, Croda, and The London Stock Exchange Group, have also produced similar results.
Ignoring Warren Buffett
Warren Buffett argues that ordinary investors should invest into a diversified index, rather than buy individual stocks. In the case of the FTSE 100, I think that it’s better to look for specific opportunities.
In fairness, Buffett’s reason for recommending an index isn’t that no individual stock will outperform the broader index. It’s that most investors aren’t able to determine which stocks will do the best.
But I still disagree with Buffett here. Companies like Experian, Halma, Croda, and the Londong Stock Exchage all have enough common features that should give an ordinary investor like me a decent shot at identifying them as winners.
Each of the businesses mentioned generates significant cash using relatively little in the way of fixed assets. This gives them an advantage that, I believe, means that they will continue to do well in future.
That’s why I’m ignoring Warren Buffett’s advice with the FTSE 100. I’m sticking to buying individual businesses that have durable competitive advantages – much like Buffett himself does in his own investing.