Just how safe is the FTSE 100? In April last year, investors were celebrating as the index hit a new all-time high of 7,122 -- more than double the 3,530 low seen in 2009.
If you'd been brave enough to pump money into the FTSE 100 during the first half of 2009, you would have doubled your money without the risk of having to pick individual stocks. This seemed to confirm the idea that investing in a FTSE 100 index tracker is all that most investors need to do to generate a satisfactory profit.
Unfortunately, last year's gains were short-lived. The index is currently trading about 16% below last year's all-time highs, at 5,835. Yet the share prices of many FTSE 100 firms have performed a lot better than this. Big companies such as Unilever and Compass Group are up over the same period.
This FTSE sell-off highlights three big risks for index-tracking investors.
Problem #1: An unbalanced index
Although it's true that the FTSE 100 is a diverse index with companies from all the main sectors of the market, it isn't an evenly balanced index.
Big banks, oil and mining firms account for £534bn, or 30%, of the FTSE's total market cap of £1,821bn. The bad news is that it's these companies that have been the biggest fallers over the last year. A year ago, firms such as Royal Dutch Shell, BP and BHP Billiton accounted for a much larger share of the FTSE 100.
The FTSE 100's uneven sector weighting is one of the reasons it has consistently underperformed the mid-cap FTSE 250 index -- which is more evenly balanced -- over the last 10 years.
Looked at like this, the FTSE 100 hasn't been a great investment over the last decade.
Problem #2: Dividend cuts?
As I write, the FTSE 100 has a reported dividend yield of 4.4%, compared to 2.9% for the FTSE 250.
Unfortunately, the FTSE 100's high yield could be the next casualty of the big sell-off. A large proportion of the FTSE's dividends cover from income heavyweights in the commodity and financial sectors.
Three of the four big miners -- Anglo American, Rio Tinto and Glencore -- have already announced dividend cuts. The fourth, BHP Billiton, hasn't yet announced a cut. However, I'll be very surprised if this doesn't happen later this year. Current forecasts suggest a cut of 35% is likely.
Of the other big dividend stocks, Shell and BP have both said they'll maintain their dividends for at least another year, while HSBC Holdings seems unlikely to cut.
However, my view is that the FTSE's current 4%-plus yield won't be sustained unless share prices fall much further, which of course increases dividend yields.
Problem #3: Are we heading for 3,500?
In the last two bear markets, in 2001/2 and 2008/9, the FTSE 100 hit the bottom at around 3,500. There's no way of knowing whether that will happen again or not.
However, one thing you can be certain of is that if the index does keep falling, some companies will fall much further than others.
Roland Head owns shares of BHP Billiton, HSBC Holdings, Anglo American, Rio Tinto, Royal Dutch Shell, BP, Compass Group and Unilever. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.