For investment advisors, understanding the differences between equal-weight and cap-weighted indices can help build the best portfolios for your clients. Each approach provides distinct market exposure, leading to different long-term results. Let’s break down how these methods perform across large-cap, mid-cap, and small-cap categories, with a focus on their 20-year CAGR and the potential impact on a $100,000 investment.
Cap-Weighted Indices: The Standard
Most traditional indices, such as the S&P 500, S&P 400 or the Russell 2000, are cap-weighted, meaning the larger a company’s market capitalization, the more influence it has in the index. This approach tends to favor the largest companies, giving them a heavier weight in the overall performance. In strong bull markets, where mega-cap stocks like Apple or Amazon surge, cap-weighted indices typically see enhanced returns.
However, this strategy can also lead to concentration risk. A handful of large companies may dominate the index, meaning a downturn in these few stocks can disproportionately impact performance.
Equal-Weight Indices: A More Balanced Approach
On the other hand, equal-weight indices assign the same weight to each stock, regardless of market capitalization. This means smaller companies have as much influence on performance as larger ones. An example of an equal-weight index is the S&P 500 Equal Weight Index, which gives equal exposure to all 500 companies in the S&P 500, compared to the cap-weighted S&P 500 where the top 10 companies can make up more than 25% of the index.
At iQUANT, we take an equal-weight approach because it provides better diversification and reduces concentration risk. By distributing risk more evenly across all holdings, equal-weighted strategies often benefit in markets where smaller-cap or under-the-radar stocks outperform their larger counterparts.
20-Year CAGR Comparison: Large-Cap Indices
Looking at the 20-year compound annual growth rate (CAGR), the performance difference between equal-weight and cap-weighted large-cap indices is substantial. From 2003 to 2023, the S&P 500 Equal Weight Index posted a CAGR of 9.9%, outperforming the S&P 500’s cap-weighted CAGR of 8.6% over the same period.
If an investor had put $100,000 into the cap-weighted S&P 500 in 2003, their investment would have grown to approximately $511,000 by 2023. However, the same $100,000 invested in the equal-weighted S&P 500 would have grown to around $658,000 over the same 20-year period. This $147,000 difference illustrates the powerful effect of just a 1.3% annual performance difference over time, showing how equal-weight strategies can lead to significantly higher long-term returns.
20-Year CAGR Comparison: Small-Cap Indices
In the small-cap space, the Russell 2000 Equal Weight Index has also shown superior long-term performance when compared to its cap-weighted counterpart. Over the past 20 years, the equal-weighted Russell 2000 produced a CAGR of 10.1%, compared to the cap-weighted Russell 2000’s CAGR of 8.3%.
With an initial investment of $100,000, the cap-weighted Russell 2000 would have grown to around $496,000 after 20 years. Meanwhile, the equal-weighted Russell 2000 would have turned that same $100,000 into approximately $672,000—a difference of $176,000. This 1.8% CAGR difference over two decades clearly demonstrates the long-term benefits of equal-weight strategies in small-cap investing, where smaller companies often drive higher growth during market recoveries and expansions.
20-Year CAGR Comparison: Mid-Cap Indices
The S&P 400 MidCap Index provides another valuable comparison between equal-weight and cap-weighted approaches. Mid-cap companies often strike a balance between the stability of large-caps and the growth potential of small-caps, making this an important category for many portfolios.
Over the last 20 years, the cap-weighted S&P 400 MidCap Index produced a CAGR of 10.0%, while the equal-weighted S&P 400 MidCap Index achieved a CAGR of 11.3%. This 1.3% difference may seem small annually, but it significantly impacts long-term growth.
For an initial investment of $100,000 in 2003, the cap-weighted S&P 400 MidCap Index would have grown to approximately $672,000 by 2023. However, the same investment in the equal-weighted S&P 400 MidCap Index would have grown to about $806,000, resulting in an impressive $134,000 difference over 20 years. This demonstrates how mid-cap investors can benefit from the broader exposure provided by equal-weight strategies, where mid-sized companies that might not dominate a cap-weighted index can still drive significant performance gains.
Why iQUANT Prefers Equal Weight
At iQUANT, we believe in the long-term advantages of equal-weight indices. This approach not only provides better diversification but also reduces the risk associated with over-exposure to the largest companies in an index. In periods of market volatility, when large-cap stocks experience significant downturns, equal-weight indices can offer a smoother ride by giving more opportunities to smaller and mid-cap stocks that might hold up better in uncertain times.
In addition, the rebalancing discipline inherent in equal-weight indices ensures that gains from outperforming stocks are regularly captured, while lagging stocks receive more capital, potentially benefiting from a future rebound.
Conclusion
At iQUANT, we favor the equal-weight approach because it provides a more balanced, risk-adjusted way to invest, preventing any single stock or sector from dominating the portfolio's performance. Over the past 20 years, equal-weight strategies have consistently delivered higher CAGRs across large-cap, mid-cap, and small-cap indices. As the examples show, this approach can generate hundreds of thousands of dollars in additional returns over time—provided the advisor stays disciplined and avoids switching strategies.