Keith Speights, The Motley Fool
4 min read
Do you think the AI trade has pushed the S&P 500‘s (SNPINDEX: ^GSPC) largest stocks to dangerously elevated valuations? Do you still want broad equity exposure without abandoning the market entirely? If you answered “yes” to both questions, one exchange-traded fund (ETF) solves that problem more elegantly than almost any alternative.
The Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) owns the same 500 companies as the S&P 500. The difference is in how it weights them. Instead of allocating more to the largest companies by market capitalization, this fund gives each of the index’s holdings an approximately equal weight of around 0.2%.
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That single structural difference produces a dramatically different risk profile. In the current market environment, the Invesco S&P 500 Equal Weight ETF could be the smartest buy right now.
The concentration problem
The so-called “Magnificent Seven” stocks — Apple (NASDAQ: AAPL), Nvidia (NASDAQ: NVDA), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL), Amazon (NASDAQ: AMZN), Meta Platforms (NASDAQ: META), and Tesla (NASDAQ: TSLA) — account for around one-third of the S&P 500’s total market capitalization. That means a passive investor in the State Street SPDR S&P 500 ETF Trust (NYSEMKT: SPY) or Vanguard S&P 500 ETF (NYSEMKT: VOO) has more than 30 cents of every dollar concentrated in only seven stocks, most of which trade at relatively high valuations.
The Invesco S&P 500 Equal Weight ETF solves this mechanically. By attempting to give nearly equal weights to each holding, it reduces the Magnificent Seven’s combined weight to 1.37% of the total portfolio. An investor who buys the ETF still owns Nvidia, Apple, and Microsoft — just in roughly the same proportions as Coca-Cola (NYSE: KO), Johnson & Johnson (NYSE: JNJ), and Chevron (NYSE: CVX).
The valuation difference between the two approaches is equally striking. The cap-weighted S&P 500 trades at a Shiller CAPE (cyclically adjusted price-to-earnings) ratio of 40.7 — near its second-highest reading in 155 years. However, the equal-weighted version trades at a significantly lower multiple, because the extreme valuations of the largest stocks are diluted across 500 equally weighted positions.
A trade-off worried investors might be willing to make
