The S&P 500 (SPX) is a capitalization-weighted index. In 2024 most of the rise in SPX was driven by a few mega-cap stocks while the vast majority of the stocks did not rise.
In the equally-weighted SPX (EW SPX) each of the 500 constituent stocks is given equal weight.
In 2024 the ratio of SPX to EW SPX was very high on a historic basis. The linked article shows that this is an unusual situation which since 1990 has been followed by a reversal where the EW SPX outperformed the SPX for years.
First of all, an equal weight ETF like RSP is not even an option in the vast majority of 401K plans out there. I worked at 4 different companies before retiring early, none of them offered RSP as an investment.
But every 401K makes it easy for you to invest in an index fund. Easiest way to build long term wealth for retirement is to make regular contributions to the index fund or ETF that your 401K offers.
For long term investors, 1990 was a great year to keep buying index funds. A Vanguard 500 fund returned more than 40% over the next 3 years after declining about 6% that year. The bust in 2008-09 was a debt crisis fueled by home foreclosures that led to the collapse of Lehman Brothers and other big banks that were leveraged on CDOs. It wasn’t because tech stocks were in a bubble. Again, people who kept buying index funds, recouped their losses over the 2 years following 2008. And the 2020 bear market was temporary and caused by Covid.
The situation today is not comparable to the 1999 tech stock bubble. The Mag 7 companies as they are called have billions of dollars in profit, so the valuations are justified. I want to own them in proportion to their size. I don’t want to dilute my ownership of the 500 biggest companies by weighting those at the bottom the same.
Since the components of the indexes are changed from time to time, does it really matter? Over the long term, are the indexes valid at all? Or are the indexes a “marketing tool”?
You can approximate equal weight with 30% S&P 500 index and 70% mid-cap index. Not perfectly. There is still a concentration in the mega-caps however, but it is much less.
Not every company offers a mid-cap option but it makes it more accessible.
I did a backtest at valueinvesting.io with the approximate equal-weight blend I suggested above. Over the available period (1972-present) the the blend’s final value was 50% higher than large cap stocks by themselves with an improvement of about 0.75% CAGR.
My earlier post is about bubble warning. I don’t consider the divergence in performance as a sing of bubble, rather an opportunity to go with equal weighted. My personal expectation is equal weighted will outperform SPY in the next 6 ~ 12 month or until the discount is erased.
With regards to S&P500 and S&P500 Equal Weight, I have a theory that could explain why S&P500 will always outperform the S&P500 Equal Weight over time.
It’s related to a kind of survivorship bias. Let’s say the bottom 10 S&P500 stocks have weight of 0.05% or so each on average, if one of them suffers a severe decline or goes bust, it’ll be removed, and the S&P500 will decline by about 0.05%. BUT, in the S&P500 Equal Weight, that dog of a company whose value dropped to zero or near zero has a weight of 0.2%, and the S&P500 Equal Weight will drop by about 0.2%. Repeat over years and decades, and the S&P500 can’t help but outperform the equal weight version.
NOTE: I haven’t thought this theory through entirely, but gut feeling it sounds correct to me. Because the smaller companies tend to go bust (or shrink dramatically) much more often than the bigger companies do.
Your gut is incorrect. Small caps grow faster than large caps, but with more volatility. If you really want to swing for the fences, small cap value is the way to go.
Not for the past decade, at least, however. Large caps have absolutely trounced small, and growth over value, for at least the last 10 years. I keep waiting for things to “return to normal”, but it hasn’t happened yet. Historically small cap value is a good place to be. This could be another reason why the equal weight S&P does not outperform the market cap weighted index over the last 10 years.
The small cap universe has significantly changed in the last decade or so. Companies are taking longer to go public and it is now more common for an IPO to start off as a Midcap and less so as a small cap. The percentage of small caps that are not profitable sits around 40% - probably the highest it has been since the Great Recession and probably the highest ever for a non-recession environment.
Also, the Russell 2000 index has virtually no requirements to join unlike the S&P 500 that commonly removes even profitable companies.
Frankly, for as aggressive as I am, the juice is not worth the squeeze to invest any significant portion of my money in small caps.
It seems that even in the large cap universe, the relative size still matters. This paper by Chen finds strong performance from 1977-2000 for small S&P500 stocks, slightly outperforming their large-cap brethren.
"if one of them suffers a severe decline or goes bust, it’ll be removed, and the S&P500 will decline by about 0.05%. BUT, in the S&P500 Equal Weight, that dog of a company whose value dropped to zero or near zero has a weight of 0.2%, and the S&P500 Equal Weight will drop by about 0.2%. "
I have the same thought. The index is removing the worst of the index on it’s own.
1 thing that does worry me about my port is the SP500 and QQQ overlap of the top positions. QQQ is of course tech heavy, that is what it is supposed to do, and I knowingly want that exposure. SPY is also tech heavy, although slightly less so than QQQ with the dominant positions. I’m using SCHD to get some non tech index exposure ( although it too has tech ).
But I am pretty heavily exposed to tech, even though I’m “diversified” with index funds. And I own a few individual tech stocks. It’s worked out well, but as they say, past results are no guarantee of future results…
Sure. But the point was that when companies slip below the S&P500 threshold, they get dropped from the index, and that action negatively affects the S&P500 by 0.05% on average, but it negatively affects the S&P500 Equal Weight by 0.2% on average (of the price drop that caused it to be ejected from the index because of their relative weights in each). And apparently it happens about 20 times a year and the actions take place quarterly.
Are you positing that because the lower portion of the S&P500 companies grow faster, that the faster growth among those will overcome the lowest ~20 being dropped each year, and that therefore an equal weight will outperform the capitalization weight overall? It is indeed possible. I wonder if anyone has ever run the numbers?
