This isn't the most popular index fund, but it might be, given the balance it offers.
If you're a fan of exchange-traded funds, you're probably also a fan of index investing. Most ETFs are constructed to mirror the performance of an index, such as: S&P 500After all, the most held exchange traded fund in the world is SPDR S&P 500 ETF Trust It aims to reflect the world's best-known market indices.
But what if the indexing goes wrong?
At first glance, this seems like a strange question. Index investing is the only way to be sure that your stock won't underperform the overall market, since you're simply buying and holding a balanced portion of the market. Hard to go wrong, right? That's why so many would-be millionaires choose index investing as the core foundational holding of their portfolios.
However, there are some situations where a simple indexing strategy might not provide the best results. We explain why, and what you can do about it.
Not all indexes are created equal
If you already own shares in the aforementioned SPDR S&P 500 ETF Trust, don't panic. That's OK. With an average annual return of about 10%, investing regularly in this fund could eventually net you seven figures.
Next time you have some extra cash lying around, consider going into a similar but different business. Invesco S&P 500 Equal Weight ETF (RSP 0.62%) Instead.
As the name suggests, this Invesco fund holds equal-sized positions in each constituent stock of the S&P 500. This is in contrast to the regular S&P 500, which is a market-cap weighted index, meaning the larger a company is, the greater its overall impact on the value of the index.
For example, a huge apple It currently represents about 7% of the total value of the S&P 500. coca cola They only make up about 0.5% of the index. But in the case of the Invesco S&P 500 Equal Weight ETF, the two companies make up about 0.2% of the fund's total assets. With an equal-weighted index, for better or worse, smaller companies have just as much impact on the index's performance as larger companies.
The structural differences between these two ETFs and their underlying indexes raise an important question: Since every stock performs differently over time, how does the Invesco fund maintain a 0.2% weighting for each of its holdings?
It's simple really: Every quarter, asset managers buy and sell stocks as needed to bring the ETF's position back to its target balance. And this ongoing rebalancing can make a big difference for you.
The S&P 500 is not as balanced as we'd hoped
You've probably felt it, even if you didn't realize it: Over the past few years, the biggest companies on the stock market have Many While larger stocks are growing, smaller ones aren't growing nearly as much: In 2017, the market's 10 largest stocks accounted for just over 21% of the S&P 500 index's market capitalization, according to Invesco calculations. Today, they make up nearly a third of the index's total market capitalization, and that share is still growing.
There's nothing inherently bad about this shift toward top-heavy investing — after all, the whole reason to buy and hold an index fund is to participate in the overall market growth led by the stock that's leading the market at the time, no matter what that stock is. Mission accomplished.
But the past few years have been the exception, posing a risk to investors who have been riding the bull market. That's because many of the factors that have allowed big stocks like Apple to rally are now NVIDIAand Microsoft Fears of a spike due to rising interest rates, a slowing economy, the emergence of artificial intelligence and a host of other factors no longer apply.
This is an opportunity for smaller companies to catch up.And while it's less dramatic, it's not like we haven't seen this kind of leadership before: Since its inception in April 2003, the Invesco S&P 500 Equal Weight ETF has actually outperformed the SPDR S&P 500 ETF Trust, despite the S&P 500's heroic large-cap-led rally since early last year.
RSP Total Return Level data Y Chart
Of course, past performance is no guarantee of future results, and it's certainly possible that the top-heavy S&P 500 could continue to outperform the Invesco fund and the S&P 500 Equal Weight Index on which it's based.
However, this cliché caveat typically applies to more aggressive, active stock-picking strategies. The performance comparisons above are based on well-proven investment assumptions. more Balance few Striking a balance when the future is unpredictable.
And the future is never perfectly predictable.
A significant advantage
Again, if you currently hold a fund that mirrors a market-cap-weighted version of the S&P 500 Index, don't panic. In the end, it may not matter much, if anything, and there's no need to sell your position, especially if the sale may be taxable.
Similarly, be aware that the Invesco fund's regular quarterly rebalancing will result in a periodic tax liability on positions held outside of a tax-deferred retirement account. This ETF has an annual turnover of around 20% (although actual capital gains distributions are negligible). This means that your tax liability will be reduced when you sell the fund in the future, but it could be a nuisance in the meantime.
Still, if you believe index investing offers the highest odds, lowest risk, and easiest path to becoming a millionaire, this little ETF tweak will at least reduce your overall risk, while potentially delivering above-average returns and getting you to seven figures a little faster than a slightly different product could.
It's food for thought in an environment that's still pretty keen on simple index investing.
