The S&P 500 is widely considered to be the best indicator of how the U.S. stock market is doing, and it's easy to understand why. After all, it contains 500 of the largest companies in the United States, and these collectively represent 80% of the overall value of all publicly traded companies.
However, one characteristic of the S&P 500 that is very important for investors to understand is that it's a weighted index, which means that larger companies account for a greater percentage of the index's performance. And with the rise of trillion-dollar megacap technology companies over the past decade or so, this weighting has resulted in a rather high concentration in just a few big companies.
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For example, the largest companies in the United States, Apple (AAPL 2.42%) and Microsoft (MSFT 2.20%), make up 6.8% and 6.2% of the entire weighting of the S&P 500, respectively. The 10 largest companies in the index make up 35.6% of the S&P 500's performance. That's more than the smallest 300 components of the index combined.
In simple terms, I like the idea of investing in 500 of the largest and most successful U.S. companies. But I don't like that much of my investment performance dependent on just a few stocks, while hundreds of others barely have any impact on my long-term returns.
A different kind of S&P 500 index fund
The Invesco S&P 500 Equal Weight ETF (RSP 1.81%) solves this problem. It invests in the same 500 companies as an S&P 500 index fund, except every single component has the same influence on the ETF's performance. That means companies such as General Motors (GM 0.69%), Occidental Petroleum (OXY 0.75%), and Hormel Foods (HRL 2.67%) carry the same weight as tech behemoths such as Apple, Microsoft, and Nvidia (NVDA 3.07%).
The idea is that if American business collectively performs well, you'll reap the benefits. But you also won't feel a significant sting if, say, Nvidia posts a bad quarterly report.
Sure, you'll miss out on some of the benefits if massive companies perform well, but this tends to be offset over time by the greater exposure to smaller components of the S&P 500, which tend to have more dynamic growth potential.
Speaking of growth potential, although the equal weight S&P 500 has underperformed the traditional version of the index during the megacap tech surge of the past few years, you might be surprised to learn that the equal weight index has actually outperformed its weighted counterpart over the long run. In fact, over the past 40 years, the S&P 500 equal weight index has produced a total return that's more than 400 percentage points greater than the weighted S&P 500.
The Invesco S&P 500 Equal Weight ETF has a 0.20% expense ratio, which is a bit higher than you'd pay for most standard S&P 500 index funds but is still on the low end for a specialized ETF product.
The bottom line
There's nothing wrong with simply buying a traditional S&P 500 index fund and holding it for the long term. Doing so has historically been a strong wealth creation strategy, and in full disclosure, I own shares of the Vanguard S&P 500 ETF (VOO 1.97%) in my portfolio.
However, the relative top-heaviness of the S&P 500 makes the index's performance disproportionately dependent on just a few companies, so if you aren't too comfortable with this level of concentration, the Invesco S&P 500 Equal Weight ETF is an alternative that could be worth a closer look.
