Equal-Weight Index Funds

By Paul R. Ruedi, CFP®

Though they have been around for over 20 years, equal weight index funds have gained extra attention this year. That is likely because S&P 500 equal-weight index funds have outperformed the standard S&P 500 index. This is not really a surprise or anything magical; a quick look at the structure of these investments can easily explain why that is the case. 

The typical index fund is what is called “market-weighted” or “cap-weighted” – it will hold companies in proportion to their market capitalization. In the standard S&P 500 index companies like Apple, Amazon, and Microsoft that are worth more are held in larger proportion than the smaller companies in the index. Nvidia, the largest holding in the S&P 500, makes up over 7% of the index.

Equal-weight indexes, as the name implies, hold an equal amount of all companies in an index. In an equal-weight S&P 500 index each company makes up about .2% of the index. No one company has a greater impact on the performance of the index than another.

Lately, the S&P 500 has become somewhat concentrated in the 7 or 8 largest companies in the index, which means those companies have a greater impact on the performance of the index as a whole. Several of these largest companies have underperformed relative to the rest of the S&P 500 this year and a couple big names like Meta and Tesla are down significantly. As a result, the standard S&P 500 index has lagged the equal-weighted S&P 500 index this year. If those handful of largest companies do better than the rest of the index, the standard S&P 500 index will outperform.

Though it is interesting to observe and understand the differences in returns between approaches, whether a person chooses to invest in an equal-weighted or market-weighted version of the same index will not have a huge impact on their investment experience. Investors certainly should not chase the performance of one weighting scheme or the other, because it seems as soon as performance gets strong enough to tempt people to switch approaches, things are about to flip and the other approach will start doing better.

How you divide a portion of your portfolio among the 500 largest companies in the US just doesn’t make that big of a difference in a globally diversified portfolio. Significantly more important are keeping costs low, diversifying across thousands of companies globally, and choosing the right mix of stocks versus bonds to fund your financial goals. If you need help with that, you may want to talk to a financial advisor.

Paul R. Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.