How does the FTSE 100 work?
Does your financial advisor sometimes refer to the FTSE 100? Have you heard the FTSE 100 referenced in the news, or have you read about it in financial publications and newspapers? Not completely sure what it is?
The FTSE 100 is an important tool for understanding how your investments are performing, because it provides a broad return for the overall market. Fortunately, it’s an easy tool to understand. Once you have a firm grasp of how the index works, you can use it to analyse your own portfolio’s performance and make informed decisions.
What is the FTSE 100?
The FTSE 100 is an index composed of the largest 100 companies on the London Stock Exchange, as determined by market capitalisation, which is calculated by multiplying a company’s share price by the amount of shares it has outstanding.
The companies on the FTSE 100 are considered to be “blue chip” stocks. That means that they’re among the country’s most established companies. Many of them are household names, such as Royal Dutch Shell, HSBC, GlaxoSmithKline, and Unilever.
The largest company on the FTSE 100 is currently Royal Dutch Shell, with a market capitalisation of £135 billion. The smallest is currently Wood Group, an energy company that has a market capitalisation of £800 million.
History of the FTSE 100
The FTSE 100 was founded in 1984 as a joint venture between the Financial Times and the London Stock Exchange. Hence the name FTSE, which is a combined acronym of the two companies. Today, the index is managed by a wholly owned subsidiary of the London Stock Exchange called FTSE.
The FTSE 100 isn’t FTSE’s only index. The company also manages more than 100,000 other indices. Some of the most commonly known are the FTSE 250, which are the next 250 largest companies after the FTSE 100, and the FTSE small cap, which is every other public company outside of the FTSE 100 and FTSE 250.
How are companies chosen for the FTSE 100?
As I mentioned, the FTSE is made up of the 100 largest London Stock Exchange companies based on market capitalisation. However, it’s not as simple as just copying the top 100 list. Share prices and share amounts change every day. If it were based on a simple calculation, the list — especially the bottom of the list — would change daily.
Instead, the FTSE’s governing board reviews the index on a quarterly basis. If a FTSE 250 company moves into the top 90, then it is considered for inclusion on the FTSE 100. Similarly, if a FTSE 100 company moves into 111th or lower in terms of market capitalisation, it is considered for droppage.
That 20-spot band between spots 90 and 110 is in constant fluctuation, so the board doesn’t give much credence to small movements. For example, if a company moves from the 102nd spot to the 99th spot in terms of market capitalisation, that’s likely not enough to get it in the index. The board doesn’t want the index changing too often.
There are exceptions to the process when companies merge or when a company is acquired. Those changes are incorporated into the index as soon as the transaction is completed.
Because of changes in size, acquisitions, and bankruptcies, the list has changed considerably over the years. The original list contained companies such as Midland Bank and Reckitt & Colman. You may know them now as HSBC and Reckitt Benckiser, respectively.
How can you use the FTSE 100?
The most common use of the FTSE 100 is to get a gauge on where the broad market is headed. You can compare your portfolio’s performance to that of the FTSE 100 to see how it compares to the overall market.
Of course, you should make sure it’s a consistent comparison. If you’re invested in highly volatile small- and micro-cap shares, the FTSE 100 and its established blue-chip companies may not make a very good benchmark.
A deVere Group financial advisor can help you determine which benchmark you should use for comparisons. He or she may also suggest investing in the FTSE 100 to get exposure to the broad market. Talk to your advisor about your portfolio and how the FTSE 100 fits into it.