RSP Showcases the Equal-Weight S&P 500 ETF Argument

Equal-weight ETFs look attractive in 2024 but also have drawbacks.

kent
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Research Lead
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Reviewed by: etf.com Staff
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Edited by: James Rubin

Will 2024 be the year of the equal-weight S&P 500 ETF? 

While the Federal Reserve may deliver a soft landing for the U.S. economy this year, investors are wise to understand that this landing means slower growth, which is not an automatic positive for the top-performers of 2023, namely the mega-cap, high growth Magnificent 7 stocks. 

This is where exchange-traded funds like the Invesco S&P 500 Equal-Weight ETF (RSP) can offer a potential solution for investors. 

From just a few months after inflation peaked at 9.1% in June 2022 to today’s rate of 3.1%, investors became increasingly attracted to interest rate-sensitive, high-growth stocks like Nvidia Corporation (NVDA) and Tesla, Inc. (TSLA). These stocks along with five other mega-cap growth stocks would become known as the Magnificent 7, a reference to their dominance. 

Today, the Mag 7 stocks face significant hurdles, particularly their above-average valuations in the face of a less-friendly-to-growth environment approaching. 

But with no obvious signs of a recession in 2024, many investors may prefer trimming exposure to what appear to be over-priced growth stocks instead of completely abandoning equities.  

A quick, easy way to maintain exposure to U.S. equities while reducing, but not abandoning, exposure to mega-cap growth stocks is an equal-weighted S&P 500 ETF like RSP. 

Equal-Weight S&P 500 P/E vs Cap-Weighted

For reference to valuations, the long-term average price-earnings ratio (P/E) for the S&P 500 is about 17. Today, the P/E for the S&P 500 is about 23, which has been pulled higher by the Mag 7 stocks that have an average P/E of nearly 30, as measured by the Roundhill Magnificent Seven ETF (MAGS). The p/e ratio for the equal-weight S&P 500 ETF, RSP, is just under 17. 

Investors who are concerned about lofty valuations of pure growth ETFs and cap-weighted S&P 500 ETFs, but also seeking diversified exposure to U.S. stocks, may find equal-weighted S&P 500 ETFs like RSP more attractive.  

Pros & Cons of Equal-Weight ETFs

While equal-weighted ETFs have advantages, such as diversification and reduced exposure to dominant large-cap stocks, there are also some disadvantages. including higher turnover and potential for lower returns. 

Here are the pros and cons of investing in equal-weighted ETFs: 

Pros

  • Diversification: By equally weighting all companies in the index, you gain exposure to a variety of sectors and company sizes, potentially reducing portfolio risk compared to market-cap weighted strategies. 
  • Reduced exposure to large-cap stocks: Unlike traditional market-cap weighted indexes with heavy weightings toward large companies, equal-weight ETFs give each company equal representation. This can lead to smoother performance and lower volatility. 
  • Lower fees: Equal-weight ETFs often have lower expense ratios than actively managed funds, making them potentially more cost-effective options. 

Cons

Lower potential returns: While offering some advantages, equal-weighting can underperform market-cap weighted strategies in certain market conditions, particularly when large-cap stocks are leading the way. 

Higher turnover: Frequent rebalancing to maintain equal weights can result in higher portfolio turnover by selling shares of winners and buying losers, potentially leading to higher capital gains taxes for investors with taxable accounts. 

Limited diversification within sectors: While diverse across market caps, equal-weighting does not provide equal exposure to all market sectors. 

Bottom Line on Investing in Equal-Weight ETFs

Equal-weight ETFs offer a compelling option for investors seeking diversification and potentially smoother performance compared to market-cap weighted strategies. Their low-cost exposure to a wider range of companies is an attractive feature. However, it's crucial to acknowledge the potential drawbacks, including lower returns in bull markets and higher turnover leading to tax implications. 

Ultimately, the decision whether to invest in an equal weight ETF depends on an investor’s circumstances and goals. If diversification and risk reduction are priorities, and you're comfortable with potentially lower returns and higher turnover, then an equal weight ETF might be a good fit for your portfolio. However, if maximizing returns is your primary objective, a market-cap weighted strategy might be more suitable. 

Remember, careful research and understanding your risk tolerance are paramount before making any investment decisions. 

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.