This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Why It Pays to Own More Than One Index Fund

Critics of the S&P 500 say that cap weighting systematically emphasizes overvalued stocks and shuns undervalued names. That pulls down long-term returns.

To correct the problem, fund companies introduced equal weighting. In an equal-weight S&P 500 fund, each of the 500 stocks accounts for about the same weight. As a result, the portfolio does not emphasis a few giant stocks.

During periods when giants lead the markets, the equal-weight portfolios tend to trail the conventional S&P 500. That happened in the late 1990s.

In this decade, small stocks outpaced large ones, and equal-weight portfolios gained an edge. During the past ten years, Invesco's equal-weight fund returned 9.2% annually, compared to 7.5% for the S&P 500.

Can the equal-weight funds continue excelling? That is hard to know. Many studies have shown that small stocks outdo large ones over the long term.

But large stocks often shine for prolonged periods. It is entirely possible that the S&P 500 will outdo the equal-weight funds for the next five or 10 years.

Fundamental funds take a different approach, weighting stocks according to such factors as total sales and dividends.

Under the system, a company with a low stock price and big sales can account for a heavy weighting. Bank of America (BAC) -- which has huge total sales -- is the fourth biggest holding in PowerShares FTSE RAFI US 1000 fundamental fund and accounts for 2.2% of assets. The bank is the 27th largest holding in the S&P 500 and represents 0.7% of assets.

Because sales and dividends are not as volatile as stock prices, fundamental funds tend to maintain relatively steady holdings and sector allocations. That can result in deviations from cap-weighted benchmarks.

In 2007, the PowerShares fund had 18.7% of its assets in financials, compared to 17.6% for the S&P 500. Then in 2008, financials collapsed, and their weighting in the S&P sank to 13.2%. The weighting in PowerShares actually climbed to 20.1%. This occurred because the sales of companies like Bank of America remained enormous, even though the stock prices fell.

The big financial stake pulled down PowerShares, which lost 40% in 2008, trailing the S&P by 3 percentage points. Then financials rebounded, enabling PowerShares to return 41.7% in 2009, compared to a gain of 26.5% for the S&P.

During the past five years, PowerShares returned 2.8% annually, compared to 2.0% for SPDR S&P 500 ET (SPY), a cap-weighted index fund.

2 of 3

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,661.27 -219.09 -1.30%
S&P 500 1,941.95 -28.12 -1.43%
NASDAQ 4,391.7730 -71.1290 -1.59%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs