Don't just focus on the Footsie

Don’t just invest in UK shares, make sure you invest across the globe. And in smaller companies too!

I’m a big fan of investing in the stock market, I think it’s a great way to build long-term wealth.

And I’ve often advocated using index tracker funds that are linked to the London stock market. So if you invested in a FTSE-100 tracker fund, you’d effectively be buying shares in the hundred largest companies on the London stock market.

Or if you bought shares in a FTSE All-Share tracker, you’d be buying shares in around 600 of the largest companies on the London market.

Tracking either index makes a lot of sense, but I think it’s a mistake just to buy one of these tracker funds and leave it at that. You need to broaden out your investment portfolio a little more, or ‘diversify’. That way, you reduce your risk and potentially make more money.

To see why, let’s start by looking at the ten largest companies in London’s FTSE All-Share index:

These figures are a little out of date but the basic point still holds true. Just ten companies comprise 38% of the London’s All-share index by value.

Global reach

On the plus side, these companies are all global businesses, so if you bought shares in all ten, you wouldn’t just be investing in the UK economy. You’d be getting some diversification across the world.

But the problem is these companies are concentrated in small number of market sectors – especially resources. There are no technology companies, no media companies, no retail chains and no insurers.

So if you invest in a FTSE All-share tracker, you’re investing in some parts of the global economy – especially resources, finance and pharmaceuticals – but other parts aren’t properly represented.

The absence of technology is especially worrying as that’s probably going to be one of the biggest growth areas for the next 20 years. I think it’s essential that you get some exposure to some of the big technology companies like Google, Apple and Amazon, and you can only really do that on the US stock market.

The other big growth area for the next 20 years will probably be emerging markets like China and India. Now in fairness, a lot of the biggest companies on the London stock market do have significant presences in those countries. Indeed a few companies are predominantly based in emerging markets – the best known is probably the banking group, Standard Chartered.

But I don’t think it’s enough to rely on UK-listed companies that operate in emerging markets. To get a good broad exposure to these fast-growing economies, you need to invest in stock markets that are closer to where the action is.

Smaller companies

Even if you don’t want to invest overseas, you can still diversify away from the big boys on the London stock market.

You can do that by investing in smaller companies that are listed in London. Some of these companies will be operating in different business areas from the corporate giants, and a few could grow to become the corporate giants of tomorrow.

Now I admit that investing in individual smaller companies is riskier than buying shares in the big boys. Small companies are more likely to go bust or hit major problems. But the overall performance of smaller companies as a whole often beats the larger fry.

Just as an example, the FTSE small cap index, made up of small companies, has risen 125% over the last ten years whereas the large cap FTSE 100 index has only risen 67%.

How to diversify

You may now be convinced that you want to invest in overseas markets and smaller companies too. If that’s the case, the next question is: how to do it?

Going overseas is pretty easy. The Fidelity Moneybuilder World index fund tracks stock markets across the world and only charges 0.3% a year. The Vanguard Developed World Ex UK Index fund is pretty similar and also charges 0.3% year. You can read more about both funds in The cheapest global index trackers.

If you particularly want to focus on emerging markets, the Templeton Emerging Markets investment trust is a good one to go for. You can read more about this trust in Five top investments trusts.

As for smaller companies, I like the Throgmorton investment trust, the Marlborough UK Microcap Growth unit trust, and the Fidelity UK Smaller Companies fund. You could invest in these funds via any of the investment platforms such as Fidelity, Hargreaves Lansdown or rplan.

Check out our video: Should you be scared of the stock market?

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More on investing from Lovemoney:

Five top investment trusts

Why you should invest in shares
Don't just focus on the Footsie

The cheapest global index trackers

The cheapest index trackers

Top 10 index trackers