I’d buy FTSE 100 shares, but not the FTSE 100

I think shares in FTSE 100 companies can be a great investment. Over the last 20 years, companies like AstraZeneca, Tesco, and Lloyds Banking Group have provided good returns to shareholders.

One way of owning these stocks is by just investing into an exchange-traded fund (ETF) that owns all the shares in the index. But I think there’s a better way for investors like me to go about it.

Buy high, sell low?

The reason I don’t like buying index-tracking ETFs is that they are committed to buying shares when they are expensive and selling them when they’re cheap. To me, this is the wrong way round.

Take 2023 as an example. Shares in Rolls-Royce roughly tripled, while mining company Anglo American saw its stock fall by around 45%. 

As a result, Rolls-Royce accounted for more of the overall index at the end of 2023 and Anglo American accounted for less. If I owned an index-tracking ETF, what would I have done?

It depends a bit on how often the fund rebalances its holdings. But by the end of the year, I’d have sold Anglo American as the price fell and bought more Rolls-Royce as the stock went up.

If I were investing into a diversified collection of stocks, I’d want to be buying them when they’re cheap and selling them when they got expensive. An ETF seems to force me to do the opposite.

Finding shares to buy

The downside to buying specific shares, rather than investing in an index-tracking ETF, is that I need to know which ones to buy. And that isn’t always easy to figure out. 

There are a couple of things investors like me can do to make their lives easier, though. One is sticking to companies that are easier to understand and the other is insisting on a margin of safety.

Take GSK as an example. The stock has a market cap of £64bn, but working out whether it’s worth that might involve forming a view on its pipeline and the likely profitability of its future drugs.

An expert in this sector might be in a position to work out more accurately whether the company is worth this much. Others, however, might want to look for stocks that are easier to assess.

Equally, though, if the stock gets cheap enough, it might be obvious even to an outsider. I might not know where GSK is worth £65bn, £75bn, or £55bn – but I’m certain it’s worth more than £1m.

Investing in UK shares

The diversification that comes with investing in an index is valuable. But I’d look to do this over time by investing in different companies as and when opportunities present themselves.

In doing so, the basic strategy I’d follow is sticking to investments where I know enough about the business to see that the stock is cheap at its current price. That’s key to investing well, in my view.

There’s a risk of underperforming the index when it comes to this strategy. However, given the inherent danger of buying high and selling low with index investing, it’s the strategy I prefer.

The post I’d buy FTSE 100 shares, but not the FTSE 100 appeared first on The Motley Fool UK.

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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended AstraZeneca Plc, GSK, Lloyds Banking Group Plc, Rolls-Royce Plc, and Tesco Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.