Equal weight investing has become an increasingly popular investment strategy in recent years. The idea is to allocate an equal amount of money to each stock in an index or portfolio, rather than weighting the holdings by market capitalization like traditional index funds do. This results in smaller companies receiving a higher allocation than they would in a market cap weighted portfolio. There are several benefits and considerations around equal weight investing.
An Overview of Equal Weight Investing Strategies
Equal weight strategies aim to provide broad market exposure while avoiding concentration risk. By allocating an equal amount to each holding, they reduce the impact that large benchmark constituents have on performance. This can provide better diversification across sectors and market caps. Some of the most common ways to implement equal weight investing are through mutual funds and ETFs benchmarked to equal weight indexes, which rebalance back to equal weights periodically. Another approach is through algorithmic or quant strategies that programmatically rebalance a portfolio to target weights.
Potential Benefits of Equal Weight Investing
Studies have shown that equal weighting has outperformed market cap weighting over long time periods. One reason is that rebalancing creates a contrarian effect – selling relative winners and buying relative losers. Equal weighting also avoids overconcentration and potential overvaluation in mega cap companies. Furthermore, by increasing exposure to smaller companies, it taps into the size and value risk premia historically associated with those segments.
Caveats and Considerations of Equal Weight Investing
Critics argue that market capitalization weighting is the most rational and efficient benchmark. Equal weighting could result in overexposure to less efficient, lower quality companies at the expense of well-run large caps. It also tends to have higher turnover and transactions costs due to more frequent rebalancing. Overall, determine whether the incremental costs outweigh the diversification and return benefits over your investment horizon.
Example Stocks for an Equal Weight Portfolio
An equal weight portfolio could hold positions across various sectors, market caps, growth rates, etc. Some example stocks that could be included are Microsoft, Apple, JPMorgan, Visa, Home Depot, Johnson & Johnson, Walt Disney, Mastercard, UnitedHealth, Procter & Gamble. The list provides a mix of technology, financial services, healthcare, consumer staples, communication services, industrials, and other sectors.
In summary, equal weight investing neutrally allocates to each holding rather than weighting by size. It can enhance diversification, avoid concentration risk, and tap into potential outperformance. However it tends to have higher costs and turnover. Example stocks span mega-caps, large-caps, mid-caps across every sector.