Although the name says “equal weighting,” investors typically don't realize how big an impact subtle changes can have.
Something strange is happening across the market today. A small number of large caps (especially NVIDIA) is driving market returns. Invesco S&P 500 Equal Weight ETF (RSP -1.07%) Market capitalization weighted average SPDR S&P 500 ETF (spy -1.68%)However, this is not an indictment on the Invesco S&P 500 Equal Weight ETF; it just shows how important equal weighting is to a portfolio.
What's Unique About the Invesco S&P 500 Equal Weight ETF?
of S&P 500 The index is constructed to be representative of the broader economy, and the approximately 500 stocks in the list are selected by humans based on fair criteria. The list is updated regularly to reflect changes such as spinoffs, bankruptcies, and changes in the overall shape of the economy. The index closely tracks the stock market.
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One of the key elements of the S&P 500 is that it uses market cap weighting. This is very easy to understand as the companies with the largest market caps are given the greatest weighting in the index. This is a logical choice as the largest companies generally have the greatest impact on the economy and the stock market.
But there's a key drawback: the biggest stocks are often the most popular stocks. For some companies, it's simply a function of their economic size and industry dominance. But in most bull markets, some stocks become so popular with investors that their market caps exceed valuation limits. Today, Nvidia is the poster child for this, with business news sites heavily promoting the company's earnings releases as market-moving events.
Considering the market cap weighting of the S&P 500, Nvidia certainly has a significant impact on the overall performance of the stock market tracked by the S&P 500. The Invesco S&P 500 Equal Weight ETF tackles the weighting issue in an entirely different way, assigning equal weighting to all stocks, changing the equation for investors.
Invesco S&P 500 Equal Weight ETF outperforms
Beating the S&P 500 Index is hard. It's worth noting that most actively managed mutual funds have not accomplished that feat, and neither has the Invesco S&P 500 Equal Weight ETF over the past year. But if you go all the way back to the inception of ETFs, they have outperformed the S&P 500 Index (represented in this case by the SPDR S&P 500 ETF).
The point is that all securities have the same potential to affect the performance of the equal weight ETF, for better or worse. Obviously there will be periods of lagging performance if you miss a few big performing companies, but generally speaking the benefits of having a greater impact from small cap gains are clearly a net gain. And conversely, limiting the impact of a few big losses (even if they were once big gainers) mitigates downside risk. Thus, downsides tend to hurt less, even in bear markets.
You can benefit from equal weighting by purchasing the Invesco S&P 500 Equal Weight ETF. But don't think that's the only thing you can do, because you can use a modified equal weighting approach with your stock portfolio. Simply calculate the number of stocks you want to own and divide that number into your investable assets. That calculation gives you your “position size.” Invest that amount in each stock you buy, and all of your positions will be equal weighted when you purchase them.
You could leave it as it is, keep the winners and cut the losers (reinvest in other stocks), and rebalance periodically. Rebalancing is a bit more complicated as an approach, takes more time, and can have higher transaction fees. But if you rebalance once or twice a year, it's not that difficult.
Your portfolio is not like the Invesco S&P 500 Equal Weight ETF
To be fair, you shouldn't compare your own handpicked portfolio to the Invesco S&P 500 Equal Weight ETF. Your goals and the ETF's goals may differ significantly. But that doesn't mean you can't copy the most important aspect of the ETF's approach: the equal weighting. And given the benefits that have accrued to the Invesco S&P 500 Equal Weight ETF over the long term, it seems like an appealing, proven way to help improve your performance, too.
