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Historically, investing consistently each month in the UK’s top 100 companies has proven to be a great way to grow wealth. However the FTSE 100 apparently hasn’t gone anywhere in the last five years. In fact, compared to September 2018, the index is up a total of just 2.6%, which is not even in line with inflation before it started to skyrocket.
To be fair, we have endured an extraordinary double recession: the Covid crisis, followed by last year’s correction. But if the FTSE 100 doesn’t change, is it better for investors to focus on other indices?
Not necessarily. And the performance of the UK’s flagship index is actually much better than it seems. Let’s take a closer look.
The hidden returns of the FTSE 100
When looking at an index chart, investors see the weighted average performance of all components over a given period. In other words, it is the combined share price movement of all the underlying companies.
However, this only summarizes capital gains. And since the FTSE 100 is almost exclusively home to mature industry titans, share price growth is not as common as growth indices such as the S&P 500 in the U.S. But maturity comes with two main benefits that make up for the lack of capital gains: stability and dividends.
Despite all the recent volatility plaguing financial markets, the index has managed to emerge relatively unscathed. And while the macroeconomic environment is far from ideal, most of these companies have managed to continue paying dividends throughout. In fact, some have even increased payouts to shareholders.
Taking into account dividends received, the true total return generated by the FTSE 100 over the last five years is closer to 26.9%. That’s 10 times more than capital gains and demonstrates the power of dividends when left to be reinvested.
Whats Next?
The index as a whole has managed to recover from last year’s correction. However, upon closer inspection, it appears that this recovery has been primarily driven by just a handful of companies. And many voters have not yet returned.
This suggests that some long-awaited capital gains could be on the horizon in the coming months. And when combined with dividends, the FTSE 100 could be on track to deliver stellar performance as we head into 2024. So it’s no surprise that the general consensus among analysts is to start buying.
Personally I agree with this conclusion. However, there are still risk factors that must be considered. The short-term performance of this index remains unclear. And if the economy worsens, stocks, even those unaffected by higher inflation and interest rates, could end up in the gutter again.
Therefore, when taking advantage of opportunities within the UK flagship index, I believe a prudent approach is to adopt pound cost averaging to spread out buying activity in the event of increased volatility. And that goes for index investors as well as individual stock pickers.