In January 2003, the S&P 500 Equal Weight Index (EWI) was created. As the name implies, this is an equal weight version of the popular S&P 500 Index. Although both indices are comprised of the same stocks, the different weighting schemes result in two indexes with different properties and different benefits for investors. There are also exchange-traded funds (ETFs) that track each of the two indexes. The Guggenheim S&P 500 Equal Weight ETF (ARCA:RSP) tracks the EWI; the ETF of choice for the S&P 500 is the State Street SPDR S&P 500 (ARCA:SPY).

Let's take a look at each type of index, the ETFs that track these indexes and how the type of weighting of the index you choose can affect your investments.

Indexes 101
Similar to many stock indexes, the S&P 500 is a market capitalization-weighted index. The market capitalization of each stock is determined by taking the share price and multiplying it by the number of shares outstanding. The companies with the largest market capitalizations, or the greatest values, will have the highest weights in the index. The weight of a company in the index is equal to the market cap of that company divided by the total market cap of all the companies in the index. For example, as of September 30, 2016, the largest constituent of the S&P 500 index was Apple (Nasdaq: AAPL) with a weight of 3.2% of the total index. The top ten constituents of the S&P 500 index comprised 18.1% of the index.

An equal weighted index is just as it sounds. Every stock in the index has the same weight, regardless of how large or small the company is. Therefore, even Apple will have the same weight (0.2%) as the smallest company that is a constituent in the S&P 500.

In the table below, we have shown a calculation of a hypothetical five-stock index, comparing a market weight versus an equal weight calculation.

Stock Return % Mkt. Weight % Equal Weight % Contribution Mkt. Weight Contribution Equal Weight
ABC 4 50 20 2 0.80
DEF 3 30 20 0.90 0.60
GHI 7 10 20 0.70 1.40
JKL 4 7 20 0.28 0.80
MNO 12 3 20 0.36 2.40
Total - 100 100 4.24% 6%
Figure 1: Equal weight versus market weight index performance

The different weighting schemes of the S&P 500 EWI and S&P 500 will result in different sector exposures as well. The sector weight of a MWI (market value-weighted index) is calculated by summing up the individual weights of the companies that will make up that sector. For EWI, the sector weight is really a direct function of the number of companies in the sector. For example, if a sector contains 45 stocks, then the weight of the sector should theoretically be (45 / 500) x 100 = 9%.

The table below shows the difference in sector weight between the two indexes as of Sep. 30, 2016. For example, in the MWI, the information technology sector had a weight of 21.2% but only 13.5% in the EWI. In the EWI, consumer discretionary was 16.5%, but its weight in the S&P 500 MWI is only 12.5%. Understanding the difference in sector make-up will help to determine which index to use.

Sector S&P 500 MWI S&P 500 EWI
Consumer Discretionary 12.5% 16.5%
Industrials 9.7% 13.5%
Information Technology 21.2% 13.5%
Financials 12.8% 12.6%
Health Care 14.7% 11.8%
Energy 7.3% 7.4%
Consumer Staples 9.9% 7.2%
Utilities 3.3% 5.6%
Real Estate 3.1% 5.6%
Materials 2.9% 5.4%
Telecommunication Services 2.6% 1.0%

Figure 2: Sector weight comparison as of Sep. 30, 2016

Turnover

In terms of each respective index, the normal market-weighted S&P 500 does need to be periodically adjusted, but not rebalanced. There will be adjustments to reflect companies that have been removed and new companies that have been added to the index. There will also be adjustments made as companies in the index issue new shares or retire existing ones.

For the S&P 500 EWI, the goal is to maintain a portfolio of 500 equally-weighted stocks while keeping index turnover to a minimum. Each stock in the index is assigned a weight of 0.20% (1 / 500 x 100). The S&P 500 EWI is rebalanced quarterly to coincide with the quarterly share adjustment of the S&P 500, which takes place on the third Friday of each quarter. Shares of stocks that performed well in the previous quarter will be sold and those that did relatively poorly will have to be bought to assure the equal weight, which is essentially a sell high, buy low strategy. However, the rebalancing will result in additional trading costs for the ETF.

Volatility
Volatility tends to be higher on the S&P 500 EWI versus the S&P 500. According to the official S&P Dow Jones Indices fact sheet data released from September 30, 2016, for the past five years, the annualized standard deviation was 12.06% for the S&P EWI versus 11.12% for the S&P 500.

This reflects the fact that smaller-cap stocks are generally more volatile than larger companies, and the S&P 500 EWI has a greater tilt toward small-cap stocks than the S&P 500.

Comparing ETFs
The Guggenheim S&P 500 Equal Weight ETF has been traded since April 2003. At the end of October 2016, its total assets were over $10 billion and the expense ratio was 0.40%. The SPDR S&P 500 ETF has been traded since January 1993. At the end of October 2016, it had $195,218.74 million in total net assets and an expense ratio of 0.11%. In comparing the two, the greater asset and lower expense ratio would suggest that the SPY is more liquid and less expensive than RSP.

The Bottom Line
Currently, it's possible to trade ETFs that represent both the traditional S&P 500 MWI and the newer equal weight S&P 500 index. Although both indexes are comprised of the same stocks, the different weighting schemes lead to very different properties of the two indexes.

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