There's a huge logical problem with equal-weighting.
If you cap-weight, then the S&P 500 is 80% of the market, which is a very reasonable representation of the market as a whole. In S&P's own delightfully mealy-mouthed, yet accurate statement, "The S&P 500 focuses on the large-cap sector of the market; however, since it includes a significant portion of the total value of the market, it also represents the market." The S&P 500 has had about a 99% correlation with the total market.
However, if 80% of the market isn't enough and you want virtually 100% market coverage, there are many cap-weighted total stock market index funds. Because they are cap-weighted
, they hold only small dollar amounts of small-caps and have no practical difficulties or excessive costs in holding them. Nor are they in any danger of breaking the mutual fund diversification rule which prohibits a fund from holding more than 10% of the outstanding stock of any single company. Nor are there issues with transaction costs; the turnover ratio of the Schwab Total Stock Market Index Fund, for example is a tiny 2%.
Cap-weighted: the S&P 500 is darn close to the whole market... but if you want the whole market, it's feasible to get it.
If you decide, for whatever reason, that what you want is equal
weighting, you are faced with a dilemma.
It is practical to operate a fund that really does follow an equal-weighted allocation to the S&P 500
, one in which each stock constitutes 0.20% of the dollar value of the fund. RSP is such a fund.
Well, sort of.
Run your eye down the "holdings" column, in which every entry should be 0.20%
But, OK. Let's call that "equal enough."
But if you are equal-weighting, then the S&P 500 isn't 80% of the market
. It isn't close to representing the market. Total Stock holds 3,630 stocks, let's say the market is about 3,500 stocks.
Equally-weighted, the S&P 500 is about 1/7th of the market. All your holdings are in 1/7th of the market; what sort of "diversification" is that?
Well, you will say... OK, just like adding an extended index fund, I will hold, say, only 20% of my stock allocation in RSP, 500 stocks, and the other 80% in EQWS, the PowerShares Russell 2000 Equal Weight Portfolio. That should give me equal weight in 2,500 stocks which is now getting to be a reasonable representation of the equal-weighted market.
Except that if
you actually want equal weighting, EQWS is a joke*. With 2,000 stocks you'd expect each to be held at 0.05% of the dollar value of the portfolio. In reality, some stocks like SpartanNash constitute 0.30% of the portfolio, and hundreds are held at percentages of 0.02% or less.
And even so, it has a 143% turnover ratio.
Now some math on the feasibility of a true equal-weight stock fund. the Vanguard Total Stock Market Index Fund holds $460 billion in assets. If it held each of its 3,630 stocks at equal weight, it would have to be holding over $125 million worth of stock in every company. However, the National Security Group Inc, ticker symbol NSEC, only has a total market cap of 44.25 million. A equal weighted stock market index fund the size of VTSMX would need three times as much National Security Group stock as exists. Thirty times as much as it would be allowed to hold under the diversification rules.
Equal-weighted: the equal-weight S&P 500 is just a small fraction of the equal-weighted market, 1/7th. But if you want anything close to the whole market, equal-weighted, you'll find that it's basically unobtainable.
(*The problem isn't necessarily with the ETF. It tracks misleadingly-named Russell 2000 Equal Weight Index. How that index is defined, I'll leave as an exercise for the reader, except to say it doesn't involve holding each of 2,000 stocks at equal weight).
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