Equal versus Market Cap-Weighted Stock Market Indices

And the winner is?

January 2025. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Equal-weighted stocks outperformed market cap-weighted stocks in 8/10 decades
  • They were also more volatile, but generated a higher Sharpe ratio
  • May appeal to investors concerned about the concentration level of the S&P 500

INTRODUCTION

Weighting stocks by market capitalization is often the most practical approach for large investors, as it minimizes transaction costs. However, it is not the only method available. Investors can also choose to weight stocks based on fundamentals like revenues or profits, use factor-based approaches, or apply equal weighting.

Conceptually, market capitalization weighting resembles a form of momentum investing, as it channels the most capital to the largest and most successful companies. Despite this, the actual exposure to the momentum factor is often modest (read Cap-Weighted Benchmarks: Good Momentum Bets?), and historically, relying on the dominance of market leaders – “the juggernauts” – has been a suboptimal strategy (read The Juggernaut Index).

With the market cap-weighted S&P 500 exhibiting unusually high concentration levels today, some investors are exploring alternative weighting methodologies.

In this research article, we will examine the comparative performance of equal weighting versus market cap weighting in the U.S. stock market.

EQUAL VERSUS MARKET CAP-WEIGHTING IN THE U.S. STOCK MARKET

While there are no public sources for equal-weighted U.S. stock market returns, we can construct such an index using data from the Kenneth R. French Data Library. For this analysis, we create theoretical market cap-weighted and equal-weighted U.S. stock market indices and compare their performance to two real-world products with realized returns: the market cap-weighted SPDR S&P 500 ETF Trust (SPY) and the Invesco S&P 500 Equal Weight ETF (RSP).

These theoretical portfolios represent the broader U.S. stock market, whereas the S&P 500 indices focu