Is equal-weight investing safer than the S&P 500? Historical performance reveals a surprising story about diversification and risk.
KEY TAKEAWAYS
Yesterday’s selloff was concentrated in chips, not broad. The S&P 500 fell 1.21% and the Philadelphia Semiconductor Index dropped 6.72% with all thirty members lower, while the Invesco S&P 500 Equal Weight ETF rose 0.73%.
Over the past twelve months, the cap-weighted and equal-weight versions of the S&P 500 delivered nearly identical returns. Through October 16, equal weight returned 16.28% and the S&P 500 returned 16.78%, dividends included.
The two indexes took very different paths to get there. The cap-weighted index fell 9.1% to its March low and then surged on mega-cap strength. The lead between the two changed hands several times during the year.
Over the past decade, the cap-weighted S&P 500 has outperformed by about three percentage points a year, 15.1% versus 12.0% through July. Since 2003, the gap narrows to 11.45% versus 11.18% annually, and the cap-weighted index was actually the less volatile of the two.
The two indexes carry different risks. The ten largest companies make up roughly 40% of the cap-weighted S&P 500 but about 2% of the equal-weight version. Smaller companies make up about 80% of the equal-weight fund, versus roughly 25% of the regular index.
MY HOT TAKES
Most investors who think they own “the market” actually own a concentrated bet on a handful of giants. That isn’t necessarily a mistake, but it should be a choice, not an accident.
The cap-weighted index’s extra volatility today isn’t random noise; it’s concentration. The same mega-caps that delivered three extra points a year for a decade are the ones behind days like yesterday. You can’t keep the returns and give back the bumps.
Equal weight is not the smooth road it appears to be after a single year. Over the long haul it has historically been the bumpier index, and its quarterly rebalancing keeps selling the market’s biggest winners on the way up.
Judging either index on twelve months of performance is like planning a commute around one night’s traffic report. The scoreboard depends entirely on which window you pick, and the honest answer is that each has had its decade.
The real question for investors isn’t which index wins. It’s which kind of risk they’re willing to sit through without hitting the sell button. A strategy you abandon at the bottom is worse than either road.
You can quote me: “Volatility is the price of admission, not a guarantee of a prize.”
There’s still time to change the road you're on. Leaving the city Wednesday evening, my wife punched home into the GPS and it offered us two routes. Both–I kid you not–showed the exact same arrival time, down to the minute. Route one was the Turnpike: brake lights, merges, a guy in a pickup who apparently believes turn signals are optional, and at least one stretch where we all sat perfectly still and admired the sunset together. Route two was the back roads: smooth, scenic, a few traffic lights, a farm stand or two, and not a single honking horn. Same ETA–SAME ETA! I recommended the Turnpike. Of course I did. My wife, who was driving, looked at me the way she looks at me when I order the same dish at the same restaurant for the fortieth time. "Why," she asked, "would anyone choose to suffer when they don't have to?" It's a fair question. My answer wasn't about that night. It was about all the other nights. Over a year of drives, the highway gets me home faster–not every single time, but enough of the time to matter. I'll take the brake lights. I just won't pretend I enjoy them. 🤣 And when I sat down at my screens yesterday morning and pulled up the last twelve months of the S&P 500 next to its equal-weight twin, I realized I was looking at the very same GPS screen. Two routes. Same arrival time. One of them made you want to scream.
Let me start with yesterday’s tape, because it told two completely different stories at the same time. The S&P 500 fell 1.21%–its worst day since July. The Nasdaq Composite dropped 2.60%. The Philadelphia Semiconductor Index–the SOX (a basket of thirty chip companies–the picks and shovels of the AI buildout)–collapsed 6.72%, with every single member down, leaving it more than 26% below its June record. Ugly. Now here’s the part that didn’t make the headlines. The Invesco S&P 500 Equal Weight ETF–the very same 500 companies as the S&P 500, except each one gets the same slice, about 0.2% apiece–ROSE 0.73%. The Dow finished flat. Small caps finished higher. Go ahead, read that again. 😉 “The market” lost more than 1%, and the average stock in the market went UP. How is that possible? Simple. In the regular S&P 500, a company counts in proportion to its size, so the ten largest companies make up roughly 40% of the index. In the equal-weight version, those same ten add up to about 2%. Yesterday, the S&P 500 wasn’t really measuring the market. It was measuring a handful of giants–and the chips that feed them.
Which brings me to the scoreboard that got me thinking. Over the twelve months through last Friday, the two versions of the very same index arrived in a virtual dead heat–16.28% for equal weight versus 16.78% for the S&P 500, dividends included. Half a point. Practically a tie. But the DRIVE? That was a different story–several different stories, in fact. This spring, the cap-weighted index fell 9.1% from its high to its March low, while equal weight held the lead for much of the year. Then the mega-caps came roaring back, and by early October the S&P 500 was up about 14% for the year versus roughly 10% for equal weight, which sat some 5.5% below its own high. Then the chip trade stumbled, and by last Friday equal weight had pulled back ahead for the year. Lead changes, gut checks, sleepless nights. If you owned the regular index, you rode every one of those swings with the mega-caps behind the wheel. If you owned equal weight, you spent most of the year cruising the back roads–and some weeks, the farm stands looked awfully appealing (especially during this time of year 🍃🎃). Same destination. Two very different trips to get there.
So here is the obvious question, and it's exactly the one my wife asked me in the car: if both roads end up in the same place, why on earth would anyone choose the one with the potholes? Why not get the same return with less suffering? It's a fair question–and equal weight deserves a fair hearing. It doesn't let any single company dominate your portfolio. It forces you to trim what has run up and add to what has lagged every quarter (that's the rebalancing–buy low, sell high, on autopilot). It spreads your money across the whole economy instead of concentrating it in one corner. And after a day like yesterday, it looks downright brilliant. If you only looked at the last twelve months, you'd sign up first thing Monday morning. But nobody plans a commute around one night's traffic report–and nobody should plan a portfolio around one year's returns.
So, let's zoom out–way out. Over the ten years through July, the S&P 500 returned 15.1% a year. Equal weight returned 12.0%. Three points a year–every year–for a decade. On $100,000, that's the difference between roughly $408,000 and $311,000. That's not a rounding error, my friends. That's real money. Go back to 2003, when the equal-weight fund was born, and the race tightens to a photo finish: 11.45% a year for the S&P 500 versus 11.18% for equal weight. And here's where I owe you some honesty, because it surprised me. Over those twenty-three years, it was the S&P 500 that gave the CALMER ride–annual volatility (how widely returns swing around their average) of 18.49% versus 19.72% for equal weight, and a shallower worst-case drop during the financial crisis, -55.2% versus -59.9%. Zoom out a full century, and researchers who rebuilt an equal-weight index found it beat the market by about one point a year–with slightly MORE volatility. So which road is the bumpy one? It depends on the decade. Historically, equal weight carried the extra bumps, because it owns more of the smaller companies. Today, the S&P 500 carries them, because it owns so much of a few giants. The lesson isn't that one road is smooth and the other is rough. The lesson is that whichever one gets you home faster usually makes you pay for it in brake lights.
And that brings me right back to yesterday. The extra volatility in today’s S&P 500 isn’t random noise. It’s concentration. When you buy the index, you are placing a very large bet on a small group of companies tied to AI spending–and on the chipmakers that supply them. That concentration is exactly what delivered three extra points a year for a decade. It is also exactly what delivered a 6.72% wipeout in chips, as investors questioned whether all that AI spending will pay off on schedule. The speed and the traffic come from the same place. You can’t keep one and leave the other on the shoulder. If those giants keep delivering, the brake lights will have been worth it. If they don’t, the regular index will feel the pain first–and most. And let me be fair to the other side of the ledger–equal weight is no free lunch, either. Every quarter, it trims its biggest winners back to size, which means that when a handful of giants runs for a decade, equal weight keeps selling them on the way up. And because every company gets the same slice, the 400 smaller names make up about 80% of the equal-weight fund, versus roughly 25% of the regular index. It’s a mid-cap fund wearing a large-cap suit. You aren’t escaping risk. You are swapping one kind of risk for another.
So here are the questions I'd ask myself this weekend. Do you know how much of your "diversified" index fund sits in its ten largest holdings? Could you have sat through this spring's slide–and yesterday's chip rout–without hitting the sell button? If the next decade looks more like the last century than the last ten years, are you positioned for it? And is the road you're on one you actually chose, or one the GPS chose for you? Most investors never picked between these two indexes at all–they simply bought "the market" and assumed it was spread evenly across 500 companies. It isn't, and it hasn't been for a long time. I won't answer those questions for you. But you should ask them.
Here's the thing about that GPS. The ETA is an estimate, not a promise. Some nights there's an accident on the highway, and the back roads win going away. The highway doesn't owe me anything just because I'm willing to sit in its traffic. I choose it because, over hundreds of trips, the odds are on my side–not because any single trip is guaranteed. That's the whole deal, and it's the same deal investors sign every time they buy an index fund. The market works the same way. As I say all the time, “volatility is the price of admission, not a guarantee of a prize.” There is no smooth-ride version of the market–only a choice of which bumps you sign up for. As for my wife? She took the back roads last week, beat me home by twelve minutes, and had enough time to walk the dog and read through a pile of mail. She hasn't let me forget it. Some nights, the smooth road wins. Just don't bet the decade on it. 😉
YESTERDAY’S MARKETS
Stocks were mixed yesterday as a selloff in semiconductor shares dragged technology lower. The Dow Jones Industrial Average edged up 12 points, or less than 0.1%, to 52,868, while the S&P 500 fell 1.2%, the Nasdaq Composite dropped 2.6%, and the small-cap Russell 2000 gained 0.1%. The 10-year Treasury yield fell about 20 basis points to roughly 4.95%, its first close below 5% in a month. Brent crude settled up 4.0% at $113.17 a barrel, and WTI rose 2.4% to $99.47.
NEXT UP
S&P Global Flash Manufacturing PMI (October) may have eased slightly to 55.5 from 55.9.
S&P Global Flash Services PMI (October) probably pulled back to 58.0 from 58.8.
University of Michigan Sentiment (October) is expected to come in at 46.3, in line with earlier estimates. Watch the inflation expectation components, which are expected to come in at 4.7% and 3.5% for short and long-term.
Next week will be a busy one with lots of important earnings announcements as well as more housing numbers, Consumer Confidence, regional Fed reports, GDP, Personal Spending, PCE Price Index, Durable Goods Orders, and an FOMC Meeting. It’s gonna be a big one, so you better show up…if you want to avoid being alarmed by a bustle in your hedgerow.