Why Size Doesn't Matter and Why Shares Outside of the FTSE 100 May Offer the Best Protection Against Risk

‘My ventures are not in one bottom trusted,

Nor to one place; nor is my whole estate

Upon the fortune of this present year;

Therefore, my merchandise makes me not sad.’

                     William Shakespeare

Investors in BP could be forgiven for feeling a little sea sick lately. Until the Deepwater Horizon disaster BP was regarded as a low risk, high yield investment and a common favourite of the FTSE 100.

Investors nursing losses from the collapse in the BP share price should regard the process as a valuable learning experience in managing exposure to risk.  FTSE 100 low risk? Think again. 

1.     Strength In Numbers

The FTSE 100 has become dominated by a few companies. According to the website www.thisismoney.co.uk just ten companies make up 47% of the value of the FTSE 100. It has risk written all over it.

This situation is to investing the opposite of the concept of strength in numbers. A large ‘supercap’ business may be less likely to falter, but the recent BP situation should make the investor pause and reflect.

2.     Size Doesn’t Matter

Vast companies can and do fail. Examples include Lehman Brothers (was once valued at $691 billion) and Enron Corp (once valued at $65 billion).

It was Warren Buffet who once said that you can’t invest in what is popular and do well. It would also seem that popularity doesn’t reduce risk either. So if size doesn’t matter, what does?

3.     Quality Matters

It is the quality of the business that matters.  A small quality company with the potential to become great will always be a safer investment than a massive supercap with poor management and leadership. 

‘A small leak can sink a great ship’.

                 Benjamin Franklin

 4.     FTSE 100 Doesn’t Mean Low Risk

Around the year 2000 technology companies accounted for about 20% of the FTSE, just before the stock market collapse. Too much concentration into too few companies is not healthy for the stock market or the investor looking to increase their wealth and limit their exposure to risk.

5.     The Solution is………

Diversify. This has been a good idea for a long time. 

‘Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth (Ecclesiastes 11:2).’

                             Hebrew Bible.

There is nothing wrong with owning shares in large FTSE 100 companies as long as the investor is not overly exposed to them.

Too much concentration in your investment portfolio into one company or sector is just as bad as too much concentration in the FTSE 100 itself. Both can magnify risk. The job of the intelligent investor is manage that risk to an acceptable level, and to remember that the FTSE 100 only provides an illusion of safety.

Jamie E Smith is the author of Making Money From Stocks And Shares

This content was provided by one of our users, Jamie