What are the potential returns of the FTSE 100?

The FTSE 100 is an index that represents the top 100 companies on the London Stock Exchange (LSE) by market capitalization. Discover insights into the historical performance of the FTSE 100. Understand how to analyze its returns and see how the index has performed over the years.

What is the FTSE 100?

The FTSE 100 is an index that represents the 100 largest companies listed on the London Stock Exchange (LSE) based on market capitalization. Established on January 3, 1984, it started with a value of 1,000.

This index is weighted by market capitalization, meaning that companies are weighted according to their total market value. To be included in the FTSE 100, companies must have a full listing on the LSE, be denominated in sterling, and meet specific criteria regarding market capitalization and liquidity.

Companies with larger market capitalizations have a greater impact on the index's movements. For instance, as of March 31, 2023, Shell, with a market cap of nearly £190 billion, significantly influences the FTSE 100 more than Pearson, which has a market cap of £6.1 billion.

How to Measure Dividend Reinvestments and Nominal Returns

When you look at an individual dividend payment, it might seem minor in relation to total returns. However, as dividends accumulate, their impact on overall returns becomes significant due to the power of compounding.

Reinvesting cash dividends increases your total holdings, which in turn allows you to earn more dividends. This creates a cycle where you earn interest on your initial investment as well as on the reinvested dividends. Over time, this compounding effect can greatly enhance the value of your portfolio.

For example, from December 31, 2012, to December 31, 2022, the FTSE 100's price return was just over 23%. However, if dividends were reinvested, the total return soared to over 84%.

To put this into perspective, if you had invested £10,000 in December 2012, your investment would be valued at approximately £12,600 after ten years based solely on index movements, resulting in a gain of £2,600.

Conversely, if you invested the same amount and reinvested the dividends, your investment would be worth over £18,500 by December 2022. This means you would have made nearly £6,000 in addition to the standard index return, highlighting the significant impact of compounding over time.

What Impacts the Performance of the FTSE 100?

The companies that make up the FTSE 100 index have a significant international presence, making them susceptible to various influencing factors. Here are some key drivers of FTSE 100 performance:

1. Currency Fluctuations
Approximately 80% of the revenue generated by FTSE 100 companies comes from overseas, with a substantial portion earned in US dollars. When the pound depreciates against other currencies, profits increase when converted back to sterling, potentially driving the FTSE 100 index higher. In 2022, this currency effect contributed to the index's outperformance compared to international indices.

2. Monetary Policy
Higher interest rates can negatively impact FTSE 100 prices. For instance, the Bank of England's base rate rose from 0.25% in December 2021 to 4%, with more increases anticipated. Rising rates elevate borrowing costs for companies, which can squeeze profit margins. However, financial firms within the FTSE 100, like NatWest, may benefit from higher interest rates, potentially offsetting some negative impacts.

3. Company Earnings
Publicly traded companies must report their performance, and when earnings exceed analysts' expectations, share prices typically rise. For example, Shell reported 2022 earnings above forecasts, leading to a strong performance in its share price.

4. Oil and Commodity Prices
Several large constituents of the FTSE 100 are involved in the oil and commodities sectors. An increase in oil and commodity prices generally boosts the share prices of these companies, including major players like Shell and BP, which are among the top five companies in the index by market capitalization. Their strong performance in 2022 helped the FTSE 100 outperform global equity indices.

5. UK Sentiment
Overall sentiment towards UK-listed companies can significantly affect FTSE 100 returns. For example, Brexit led to negative sentiment that impacted the index’s performance for four years post-referendum. During this period, investors would have seen better returns from US equities or even emerging markets, despite their own political challenges.

What Has Been the Range of Potential Returns for the FTSE 100?

Equity markets typically reflect economic activity, often declining before a recession and rising in anticipation of recovery. The chart below illustrates the range of annual returns for the FTSE 100 over the past 35 years.

Investing over a longer timeframe can decrease the likelihood of experiencing a loss on your investment. This can be demonstrated by examining various holding periods and identifying the lowest annualized return for each timeframe.

The worst two-year return since the inception of the FTSE 100 was -33%, equating to an annualized loss of -18%, from December 31, 2000, to December 31, 2002. The most significant five-year annualized return occurred between December 31, 1999, and December 31, 2004, with a rate of -4% per year.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.