I like the FTSE 100 and believe it to be a decent investment vehicle for building wealth over the long term.
I’d approach an investment in the index by paying regular monthly payments into a tracker fund held within a tax-efficient wrapper such as a Stocks and Shares ISA or a Self-Invested Personal Pension (SIPP).
But why do I like it so much when some of the firms within it look like absolute duffers?
Impressive compound total returns
The FTSE 100 has historically delivered a substantial dividend yield. Right now, the yield is knocking on the door of 4.5%, but in fairness, that’s a little higher than ‘normal’. It not unusual, though, for the yield to be north of 3%, and I tend to think of the FTSE 100 delivering a big portion of its returns to investors in the form of income from dividends.
However, income isn’t the whole story, and a big part of your returns from the Footsie over the long haul will come from the process of compounding when you automatically reinvest all the dividends by selecting the accumulation version of a tracker fund rather than the income version.
According to IG, the compound return of the FTSE 100 with dividends reinvested over the past 10 years has been around 8.8%. So, a lump sum investment at the beginning of the period would have delivered a total return of 121% by the end of the period.
And over 25 years, the compound annual return was 6.4% with dividends reinvested, delivering a total return of 375% by the end of the period. I think that’s a good starting point for a long-term investment.
Bounce-back potential
A quick glance at the long-term chart for the FTSE 100 reveals many ups and downs within an overriding trend upwards. And one of the great characteristics of the index is that it has always, so far, bounced back from its lows.
The thing about cyclicals is that profits and share prices tend to cycle up and down. But if we invest in monthly chunks – a process known as pound-cost averaging – we can take advantage of that phenomenon. When the index is down in a dip we’ll get more units of our FTSE 100 tracker for our money. And those monthly investments made at the lows can deliver tremendous gains on the next up-leg of the index when it comes.
Self-cleaning feature
But if some of those cyclicals fall too hard during a down-leg, we needn’t worry. The index is self-cleaning because poor-performing companies will be ejected from the index if their market capitalisations drop too far down, and they’ll be replaced with up-and-coming firms that are performing well.