Passive investors can leverage the collective wisdom of active investors by market-cap-weighting the holdings of an index. A stock's weighting in a market-cap-weighted index moves with its share price. The knock on market-cap-weighting is that it could lead to single-stock and sector concentrations in the most expensive parts of the market. Equal-weighting the stocks in an index attempts to bypass this possible tilt toward expensive names by severing the link between a stock's portfolio weighting and its price.
Invesco S&P 500 Equal Weight ETF (RSP) effectively delivers mid-cap stock exposure by weighting the stocks in the S&P 500 equally instead of by their market cap. This approach increases the fund's exposure to the smaller and riskier stocks in the S&P 500. Equal-weighting diversifies firm-specific risk but leads to persistent sector bets that may not always pay off. The fund's low fee offers a durable cost advantage, but there are market-cap-weighted mid-cap stock funds available for a fraction of the fee. It earns a Morningstar Analyst Rating of Bronze.
Adam McCullough, CFA has a position in the following securities mentioned above: AAPL AMZN. Find out about Morningstar's editorial policies.