The S&P 500 is getting too top-heavy, and that makes equal weight ETFs more appealing than ever.
Index funds are supposed to reduce your risk by spreading your money across several companies. The S&P 500, however, is a market-capitalization weighted index. This means that companies with the largest market caps carry the greatest percentage weights while companies with smaller market caps have lower weightings.
Companies’ market caps change over time, however. When that happens, the S&P 500 index is adjusted accordingly. We’re seeing this play out right now.
While previous tech darlings have faded, investors have been shifting more money toward Apple and Microsoft. The combined weighting of these two companies in the S&P 500 now sits at an all-time high of 13.3%.
A distorted view of the market.
The S&P 500 is widely considered one of the best gauges of large U.S. stocks, and even the entire equities market.
But is that still true?
With just two stocks now holding a combined weighting of over 13%, it’s valid to ask if the index’s overweighting toward larger companies provides a distorted view of the market.
If you own a S&P 500 ETF like SPY, far more of your funds are invested in the top ten companies (by market cap) than those toward the bottom of the index.
Concentrating on the largest businesses may seem like a safe allocation, but just because a company is in the top 10 of the S&P doesn’t make it a great investment. First of all, smaller companies typically experience more growth than mega-caps.
Second, the composition of the top 10 frequently changes as companies become more or less valuable.
Check out this amazing video that shows how the largest companies by market cap have changed from 1979 to 2021.
The video includes companies from across the world, so it’s broader than the S&P 500. It still illustrates my point, however, which is that overweighting your portfolio solely because of market cap can be a mistake.
Lastly, I recently recommended 7 new positions for the Antagonist Blend Portfolio, 3 of which are index ETFs. In that article, I compared market-cap weighted and equal weight ETFs—and why you might consider one vs. the other.