The FTSE 100 has come within spitting distance of its all-time high this week. As I write on Tuesday, it is within 1% of that level.
But while the FTSE 100 is moving up – and has gained 3% in the past year – it is not the same story across the whole stock market. Over the same period, for example, the FTSE 250 index has fallen 12%. So, rather than invest in the larger index, ought I to sell all my shares from it and put the money into FTSE 250 companies instead?
Here are three reasons I do not think so – and one possible reason in support of such a move.
High prices and valuation
Does a high index price mean that the shares in it are overvalued?
Not necessarily. The FTSE 100 looks pricey compared to its historic levels. But that might not be a useful comparison for me as an investor.
Take one of the member companies in which I own shares, JD Sports. It is on course to make record profits this year. That could support a higher share price than the retailer merited before, using a valuation method like the price-to-earnings ratio.
Just because FTSE 100 shares as a group hit a higher collective price than before does not necessarily mean that they are overpriced relative to their future earnings potential.
Buying shares not an index
Some companies could be underpriced even in an expensive index. By the same token, a low FTSE 100 level never guarantees that any particular share offers good value.
If I was buying an index tracking share, I might view things from a different angle. But when choosing individual shares I think offer long-term value relative to what I pay for them, I focus on each share price in isolation.
What the wider index is doing does not make a share good or bad value for my portfolio.
Past and future performance
What has happened in the past in the stock market is not necessarily an indicator of what will come next.
A new high could be followed by the FTSE tumbling. Alternatively, it could reach that level then plateau for years. Or the index might keep climbing and reach a succession of new high points in a bull market over the coming years.
So when deciding whether to increase or reduce my exposure to FTSE 100 shares, I ignore the historical performance of the index. I try to stay future-focused.
Future growth hopes
But while I see good reasons to hang on to many of my FTSE 100 shares, I also think the falling price of some FTSE 250 shares could give me a buying opportunity.
They are firms with smaller market capitalisations than those in the index of 100 leading companies. That could mean that their businesses have bigger space to grow.
As the economy recovers in coming years, being exposed to firms with strong growth prospects could potentially be a rewarding investment strategy. That is why I have been adding some beaten-down FTSE 250 shares to my portfolio in recent months, like abrdn and Dunelm.
I see opportunities in both indexes and am actively looking for attractive shares to buy from either.
C Ruane has positions in Abrdn Plc, Dunelm Group Plc, and JD Sports Fashion. The Motley Fool UK has no position in any of the shares mentioned. 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.
Motley Fool UK 2023