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The top 5 largest publicly traded companies in the US, makeup 21.5% of the weighting of the S&P 500 and can have a huge impact on the performance of the overall index. In this video, I take a look at the merits of investing in an equal-weighted fund.
This video is for informational and educational purposes only and should not be construed as financial advice.
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Further reading: https://irishfinancial.ie/which-sp-500-index-market-cap-vs-reverse-cap-vs-equal-weighted/
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0:00
Diversification is something that is very important when you are investing, but when you invest in something like the S&P 500, are you really diversified
0:07
When we talk about the S&P 500, we're talking about the 500 largest publicly traded companies in the United States
0:14
but each company's weighting on the index is dependent on what their market cap is
0:18
which can mean that some large companies can have a huge impact on the performance of the S&P 500 index
0:24
compared to some of the smaller companies that are also listed in this index
0:29
To illustrate this, let me explain it with the aid of some golf balls
0:32
So this bucket of golf balls represents the S&P 500 somehow. Let's have a look at some of the companies that are included in it
0:40
So first up, let's have a look at Etsy. So Etsy is a company that is valued at 12.6 billion and only makes up 0.04% of the S&P 500 in terms of its market cap size
0:54
Then another company on the list here is Kellogg's. Kellogg's is valued at 24.5 billion at the moment and that makes up 0.06% of the total market cap of the S&P 500
1:06
So it's a relatively small company as well. Then you have a company like Twitter
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Twitter is worth around 40 billion at the moment in terms of its market cap. And that makes up 0.11% of the total market cap of the S&P 500
1:20
So all of these small companies together, they're all kind of relatively equal size
1:24
But then you add in the likes of Apple. So Apple has a market cap, a huge market cap of 2.35 trillion and that 2.35 trillion makes up a total of 7% of the total weight of the S&P 500 index
1:40
So it's massive impact on the whole index. Then you can add in companies like Microsoft on top of that as well
1:46
So Microsoft has a market cap of 1 trillion and makes up 5 of the weighting of the whole S 500 In fact if we take the top five companies alone that is Apple Tesla Microsoft Google and Amazon their total market cap weighting in the S 500 index at the moment comes to 21 and if
2:08
we extend that again to the top 10 companies that are listed on the S&P 500 that brings us up to a
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total market cap weighting of 28.59% so when you are invested in the S&P 500 you're heavily invested
2:21
in those top 10 companies compared to the other 490. And those companies that I listed off there
2:27
the likes of Apple, Tesla and Google, Microsoft, they're all tech stocks. So when you're invested
2:32
also in the market cap weighted S&P 500, your investment is also heavily weighted towards the
2:38
tech industry. If we have a look at the breakdown here, we can see that tech stocks make up 28% of
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the weighting of the S&P 500. And that's compared to just 11% for the likes of consumer discretionary
2:49
just 4% for energy and 2.96% for utilities. That's actually worked out quite well for a lot
2:56
of investors over the last number of years because we have come off one of the biggest
3:00
bull markets in a long time. We've had low interest rates for the best part of 20 years
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and lots and lots of money printing and a lot of that capital ended up flowing towards the likes of
3:09
tech stocks. But now obviously with the inflation crisis and the sharp rise in interest rates to
3:14
combat that, tech stocks in particular have taken a huge beating. If you didn't like the idea of
3:19
having stocks such as Google, Microsoft, Tesla or Apple having too much of a bearing on your
3:24
performance of your returns on your investment, then you can also go with something like an equal
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weighted S&P 500 index instead. Everybody will have different levels of diversification that
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they want to achieve. Some people will be happy with the market cap weighted index but if you want
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something that is really really spread out and you're making sure that you're equally invested
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in pretty much every different industry, then you might be better off going with an equal weighted
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index With this index all companies no matter what their size are will have an equal weighting So all companies on the S 500 will have roughly a weighting of 0 So what that means is when you are invested in an equal weighted index
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you're going to be equally invested in the likes of Apple, which is the largest company in the S&P 500
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and also equally invested in some of the very smaller companies on the S&P 500
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such as Ralph Lauren. So the performance of both of these companies will have an equal bearing on your overall returns
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compared to the market cap weighted index where Apple would have had much a bigger bearing on your returns than the likes of Ralph Lauren
4:27
Here is just a little bit more detail on how the S&P 500 equal weighted index works
4:32
So it rebalances every quarter. So obviously within the quarter some companies are going to perform well and some companies are going to perform worse
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That would mean that say at the end of the quarter some company might end up being worth 0.25% of the weighting of the whole index
4:48
and some company might end up performing badly and end up being weighted at 0.15% of the whole index
4:56
What will happen at the end of the quarter then is they will sell off some of the winners
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and they will buy more of the losers and restore that balance of 0.2% invested in each company
5:06
There is a bit of a downside to all of that additional trading. It will mean that your actual expense ratio of an ETF that tracks this index is likely to be higher
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than that of the market cap weighted index. Historically speaking the equal weighted index has been more volatile than the market cap weighted
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That is because we have a bigger exposure to smaller companies. And the share prices of smaller companies tend to be a lot more volatile than those of larger cap companies
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The equal weighted index has also tended to outperform the market cap weighted index in times of downturn and recovery
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Let's just compare now exactly how they have performed over the last couple of years
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So year to date up to the middle of October the market cap weighted index has found itself down roughly 21 But on the other hand the equal weighted index is slightly down less at 18 so the equal weighted index has outperformed here or maybe the correct
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terminology to use here is performed less worse because nearly every stock under the sun is down
6:07
significantly this year. If we look at the charts then over the last year it still shows that the
6:13
equal weighted index has slightly outperformed at a loss of 15.9% versus the market cap weighted
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index which was down 17.6%. If we look back over the last five years however the performance flips
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where the market cap weighted index outperformed the equal weighted index and this is obviously
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because tech stocks definitely would have outperformed the market over those last couple
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of years during the bull market and if we extend that back even further over the last 10 or 11 years
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to when the bull market originally started. The market cap weighted index is up 235
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versus the equal weighted index only up 214%. So there was a bit more of a gap over the last 11 years
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In terms of which one you should choose yourself to put as part of your own investment portfolio
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obviously that is up to yourself, but it really kind of boils down to
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whether you think tech stocks are currently over or undervalued. If you think tech stocks have a lot more pain to come
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and are going to see further drops in the share price, then you're definitely going to be better off going with an equal weighted S&P 500 index
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But on the other hand, if you expect tech stocks to lead the way in the recovery
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once the market starts to get on the uptick again, then the S&P 500 that is market weighted is definitely going to outperform the equal weighted index
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So it's whatever you believe tech stocks are going to do. That is the main deciding factor
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Anyway, that is pretty much it for my video today. Thanks very much for taking a couple of minutes to watch it
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I hope you enjoyed it. If you did, I would really appreciate it if you put one of those little thumbs up down in the little corner there and subscribe to my channel so you can come back and watch another amazing video
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