if you have an index fund, it's usually weighted by the size of companies, and that means that a US Stock fund will be heavily concentrated in just a handful of Magnificent Seven stocks. In this video, we'll look at an alternative, which is an equal-weighted US Stock fund. What are the pros and cons, and who is this suitable for, and how do you do it? This video is sponsored by Saxo, an award-winning UK investment platform. Before we begin, let's just dig into what we mean by an equal weighting, but also the alternative, which is market cap weighting. Now, traditionally, if you buy an index fund, it's going to be market cap weighted. This means that the amount, the cash holding of each stock which the fund holds, is in direct proportion to the market capitalization of the stock. Market cap is just the number of shares which are freely tradable multiplied by the price of each share. So, Apple, for example, as I make this video, is worth about 3 trillion in terms of market cap. In contrast, an equal-weighted index is

very simple. It just holds equal amounts in all of the shares held by the fund. So, here, for example, is a market cap weighted S&P tracker. This is an ETF, and you can download the individual holdings of all of the stocks in the fund. And if we look at Apple, for example, you can see that its holding is about 7% of the entire fund. And that's because, as a proportion of the S&P 500, the market cap of Apple is about 3 trillion. The S&P's total market cap is about 46 trillion. So, that's about 7% of the overall index. So, here, you can see the weights of the top five and the bottom five stocks in the index sorted by market cap. Notice the huge difference in market cap between those juggernauts at the top and the tiddlers at the bottom. So, when you get to the very tail of the S&P 500, the holdings are just 0.1%, and that's a very small proportion of the overall index. Now, the dashed yellow line that you can

see here is the equal weighted waiting if you go for that instead. And the thing to notice is that the mega caps at the top of the table have a huge weighting relative to that equal weighting. That means that if you switch to an equal weighted index, you'll have a lot less of those stocks, which is precisely what people want. At the same time, for the tiny stock at the bottom of the S&P 500's market cap table, you'll own a lot more of those relative to a market cap weighted index. Now, at the moment, lots of people are quite nervous about holding the S&P 500 or even a global index fund, and that's because it's so dominated by just a handful of stocks. We can see that graphically if on the x-axis we plot the market cap table with the largest stocks on the far left, the smallest stocks on the far right, that's by market cap, and then the percentage weight in the index on the Y-axis. Notice how quickly that distribution tails off. It really is very dominated by the top of the table.

that Apple, Microsoft, and Nvidia are the top three companies by market cap as I make this video. They make up 1.15% of the S&P 500. The top five stocks make up a quarter of the index. The top nine make up a third, and the top 30 stocks make up a half of the S&P 500. And again, if we compare that with a dashed yellow line at the bottom of the graph, if you held an equal-weighted index, you just own 2% of all those stocks. So if we compare the market cap weighting with the equal weighting, and again we look at each of the stocks in the S&P 500, largest on the left, smallest on the right, you can see that the relative weighting switches at the 100th stock in the S&P 500, such that any stock which is larger than the 100th, i.e. the top 100 stocks in the S&P, those are going to have their weight reduced in an equal-weighted index, whereas all of the stocks from the 100th to the

500th stock are going to have their weight increased, and by the time you get to the 53rd stock in the S&P 500, there are actually 503 stocks in it at the moment. You're going to increase its weighting by a factor of 30 when you switch to an equal-weighted index. So when you switch from market cap weight to an equal-weighted index, it's a very dramatic shift. You've got a lot less of the huge companies and a lot more of the smaller companies. So those are the consequences of switching to an equally weighted index, and in a moment, we'll talk about the benefits and the drawbacks of having that tilt. Today's video is sponsored by Saxo. If you're an investor looking for a premium investment experience without premium prices, Saxo has revamped its fee structure and platforms to give you better value and more control. UK investors enjoy commissions of just £3 per UK trade and $1 per US trade, plus Saxo charges no custody or platform fees, and currency conversion fees are just

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link in the description below. Now let's look at the benefits of an equal-weighted index. Here you can see the historic concentration of the S&P 500 in the top 10 stocks. Currently, we're at over 30%, and that is unusual. Although if we go back to the 1950s and the 1960s, there was a comparable concentration, but most of the time since then, the concentration has been much lower than it is now. Usually, it's between about 15 and 20%. So one of the benefits, one of the obvious ones, and the one which people usually think about when they're using an equal-weighted index, is that you're moving away from that concentration in just a handful of names. In fact, most people naively when they come to investing probably think that it is equally weighted when you buy the S&P 500. You'll have equal cash amounts of every stock. Now, as it happens at the moment, it's been Mega cap tech stocks which have really dominated the cap table, so you also implicitly have a tilt

towards tech companies. So, by moving away from that, you're not going to have so much concentration in tech, but critically, the fate of your investment won't hang on the success of just a handful of companies. So, the first benefit of this tilt, the obvious one, is that you're reducing that concentration risk. There's also the potential for higher returns when you tilt your portfolio to these smaller companies. MSCI has two versions of its U.S. index. One of them is equal-weighted, the other one is market cap-weighted. And here you can see a comparison of the two. The orange line shows you the market cap-weighted version. The blue line is the equal-weighted version. And certainly, over the period since 2009, you can see that the market cap version has outperformed. But if we go back to 1994, notice that the equal-weighted version of the index has outperformed, but only slightly. And if we break it down year by year, and that goes back to 2010, I've highlighted with arrows the years in which the equal

weighted version of the index is outperformed, and certainly early on during that period, there were several years when it did. Now, the kind of environment in which these smaller stocks outperform would be one in which we're moving away from a recession into a period of growth, or alternatively, we've just had a depression of stock prices due to bad news or a crisis, and stocks are rebounding, coming out of that crisis. So, there is at least a potential for outperformance if you have this tilt towards smaller companies in the S&P, but it's by no means guaranteed. Another benefit of tilting away from those very large stocks is that they tend to be very highly valued at the moment. In September of 2024, usually, overvaluation means underperformance. So, by tilting towards the value end of the S&P 500, presumably, that should increase your odds of performing better. So, if we look at the mega-cap 8, according to Yardeni, their valuation is 26.4 times forward earnings. If we strip those out of the S&P 500,

well then, the valuations fall to a much more reasonable 18.7 times. So, value would be another reason why you might want to buy an equal-weighted version of the S&P. Now, let's switch to some of the drawbacks. The first one is about risk, and here I'm thinking about the fluctuation in price of your investment. The volatility is the typical percentage price move, and for that, it's higher if you own small-cap stocks. They just tend to be more volatile. So, by having an equal-weighted index, remember the big tilt is towards those smaller companies, so the volatility is a bit higher. So, the volatility over the last decade, for example, for the MSCI USA index is about 15.5%. Whereas for the equal-weighted version of the index, it is just under 17.7%. Furthermore, during periods of crisis when the index crashes, you can see that the equal-weighted index fell more. So, that fell by 60% in 2007, whereas the MSCI USA index only fell by 55%. Not a

huge difference, but there's just more pain. That also means that the additional return you receive comes with a higher risk. And if we think about it in terms of Sharpe ratio, which is the number of units of return you receive divided by units of risk, that Sharpe ratio is lower for the equal-weighted version of the index. Another point about the equal-weighted version of the S&P is that it tends to have higher costs that go with it. That's for the fund manager. The reason why that is is twofold. With a market cap-weighted index, if you buy the index in the first place, well, as share prices increase and decrease, so does the market cap. So, the fund manager doesn't have to do anything. As the prices of stocks move around, the market cap weighting will simply track the price movements. They only have to buy and sell if people put money into their fund or take money out, inflows and outflows. That makes the management of the fund easier, and there's less buying and selling to do. There's less turnover of the stocks.

whereas for an equal-weighted version of the index, if the price goes up, well, in that case, the fund manager is going to have to sell some of that stock, and if the price goes down, it has to buy some more. Furthermore, by having this huge tilt towards the smaller stocks, they tend to have bigger bid-offer spreads. The difference between the buying and selling prices is higher because they're less liquid than the large caps. That also increases the transaction costs for the fund manager, and those will be passed through to you. So, if you want to find funds that give you access to the equal-weighted version of the S&P, say you can find them on just ETF. And here, what I've done is I've got some S&P trackers, the market cap-weighted ones, alongside the equal-weighted version of funds that track the S&P. Notice that for the equal-weighted version of the S&P, the fund costs are 2%, whereas for the market cap-weighted version of the S&P 500, the fees are much lower, about a

third of that another drawback of tilting away from the Magnificent s say is that they're magnificent. They're magnificent for a reason. They've got very high margins. They're very profitable, and they're dominating the market because of their huge global success. Now, it's unlikely that that success is going to go away overnight, so by tilting away from those companies, you're potentially giving up further upside that they'll generate. Although, as an aside, it's probably worth mentioning that only three of The Magnificent 7 survived in the original movie. That's not a prediction, of course. So, is the equal-weighted version of the S&P suitable for you? Now, as regular viewers know, I'm a big fan of simplicity, and personally, I think that having this tilt towards smaller stocks creates complexity in your portfolio. Not in the execution, certainly. It just means buying another fund instead of a market cap-weighted one, but it certainly is a very large tilt. As we saw at the beginning, you are buying a lot more of those

smaller stocks in the S&P 500, and you'll always be second-guessing yourself, thinking, Have I done the right thing? particularly if it underperforms. Another point is that it's a higher-risk investment because the volatility is higher. If there's a market crash, it'll probably fall a bit more, so you've always got to think, Is this additional risk going to be justified by a higher return? and that also applies to the costs. We've seen that because of the greater churn and because of the mechanics of the weighting, there's more transactions, and those transactions cost more for an equal-weighted version of an index. So, will the outperformance be greater than the additional costs you're paying in terms of maintaining the fund? And then my final point is, do you actually need a tilt? There wasn't a huge difference in the equal-weighted version of the index versus the market cap-weighted version, certainly over the long run. So, you should always ask yourself, Do I really need this additional complexity, and is it going to pay off? So, personally

I don't have a tilt away from the mega caps in my Global Index Fund, which makes up the core of my investments. I could do that, but I'd also have to break it down regionally if I did that into the US, Europe, Japan, and so on. And then I'd substitute an equal-weighted index for the US exposure. But if you are concerned about the concentration that we see at the moment, a historically high concentration, it has to be said, in those mega caps, then this is certainly one way of implementing that view. You don't have to have all of your US exposure in that equal-weighted fund; you could split it between an equal weight and market cap-weighted fund based on which one you think is most likely to outperform, maybe probability weight it. Now, don't forget our offer from Saxo. As a viewer of Pension Craft, you get a special welcome bonus if you open an account. You receive up to £200 back on online trading fees. Now, terms and conditions apply, but if you want to learn more about that, look

in the description below, and as always, thank you for listening.

Equal Weight S&P 500: The Smart Investor’s Choice?

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

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Equal Weight S&P 500: The Smart Investor’s Choice?

Equal Weight S&P 500: The Smart Investor’s Choice?

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