The S&P 500 is widely considered the best measure of how large U.S. stocks are doing, but it is also a rather top-heavy index. Since the S&P 500 is weighted in favor of larger companies, and several megacap stocks have surged in recent years, the index is highly dependent on just a few massive stocks. This is great when these companies are performing well -- but not so much when they perform poorly.
An equal-weight S&P 500 index fund like the Invesco Equal Weight S&P 500 ETF(NYSEMKT: RSP) could be a great alternative. Here's what it is, and why you might want to take a closer look at it now.
A great way to invest in the S&P 500 without too much company-specific risk
S&P 500 index funds like the Vanguard S&P 500 ETF (NYSEMKT: VOO) are designed to match the benchmark's index performance and invest in the stocks of the 500 companies that it is composed of.
One important thing to know about the S&P 500 is that it is a weighted index, which means that larger companies account for a greater percentage of the assets in index funds that track it. As the largest of the large-cap stocks have grown exponentially over the past decade or so, this has left the S&P 500 reliant on just a few companies for a large percentage of its performance.
In fact, as of the latest information, the eight largest holdings in the Vanguard S&P 500 index fund make up about 31% of its total assets.
On the other hand, the Invesco S&P 500 Equal Weight ETF allocates its assets evenly among all 500 companies that make up the benchmark index, with about 0.2% in each one. That means that smaller S&P 500 components have the exact same influence on the fund's performance as megacaps like Apple(NASDAQ: AAPL) and Nvidia (NASDAQ: NVDA). In short, the ETF is an investment in 500 of the largest U.S. companies -- but without letting any of them disproportionally affect your performance.
Don't let recent underperformance trick you
In recent years, the equal weight S&P 500 index has underperformed the standard benchmark, by a wide margin. Over the past three years, the total return of the S&P 500 has been about 12 percentage points higher than the equal weight version. Over the past five years, the gap is about 22 percentage points, and over the past decade, the difference has been 57 percentage points.
However, think of what has caused this. The gains in the stock market over the past few years have largely been fueled by megacap technology stocks. But this has also left the index vulnerable to the performance of these massive companies.
Over the long run, you might be surprised to learn that the equal weight S&P 500 index has outperformed the standard version.
Time Period | Equal Weight S&P 500 | S&P 500 | Difference |
|---|---|---|---|
3 years | 15.7% | 27.8% | (12.1%) |
5 years | 66.2% | 88.6% | (22.4%) |
10 years | 172% | 229% | (57%) |
20 years | 590% | 574% | 16% |
30 years | 2,270% | 1,910% | 360% |
Data source: yCharts. Performance figures are total returns and are through 4/29/2024. Parentheses indicate negative numbers.
One caveat to keep in mind
One big drawback is the cost. While there are several major S&P 500 ETFs to choose from, there's only one major equal weight version, the Invesco product mentioned earlier. It has a 0.20% expense ratio, which is quite reasonable for a unique index fund, but is significantly more than the 0.03% expense ratio of the Vanguard S&P 500 ETF.
For context, this means that if you have $10,000 invested in the Vanguard S&P 500 ETF, only $3 of your annual investment returns will go toward fees. On the other hand, with the equal weight ETF, it will be $20. To be clear, this is still a rather cheap index fund – it just isn't as cheap as some of the standard S&P 500 ETFs you can invest in.
The bottom line is that the S&P 500 Equal Weight ETF could be a great way to invest if you want broad stock market exposure without relying too heavily on any individual company's performance. If a megacap like Nvidia plunges by 20%, for example, it would cause a noticeable drop in the S&P 500 but would barely be apparent in the performance of the equal weight index. If this type of broad market exposure sounds appealing, the Invesco S&P 500 Equal Weight ETF could be worth a look.
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Matt Frankel has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Apple, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
