1 No-Brainer S&P 500 ETF to Buy Right Now for Under $1,000

One of the most important aspects of S&P 500 the index is how it is weighted. While its market cap weighting approach was an improvement over how Dow Jones Industrial Average was designed, it exposes the S&P 500 — and any products that track it — to additional risk during periods of excess.

Hence the addition Invesco S&P 500 ETF Equal Weight (RSP 0.77%) in your portfolio could be an unusual move today if you have $1,000 in cash available to invest.

Why is weighting so important to the S&P 500?

When the Dow Jones Industrial Average was created, people had to do the math by hand.

So when it became the leading indicator of market performance, the people who designed it chose a simplistic method for calculating its level: just take the stock prices for each of the 30 selected stocks and divide by 30. (This is actually an oversimplification: The method also requires you to divide by the “Dow Divisor,” which is adjusted to account for things like stock splits.)

Because of this, at the end of the day, the stocks that have the biggest impact on Dow movements — which you can invest in with SPDR Dow Jones Industrial Average ETF (DIA 0.56%) — are the ones with the highest share prices. This is not ideal.

In contrast, the S&P 500 index is weighted by market capitalization. This means that the largest companies by size have the greatest impact on its performance, as they make up the largest part of the index. This makes more sense as the largest companies will normally be the most important companies in the economy. The index also tracks 500 companies, as opposed to the 30 in the Dow.

Overall, this much broader diversification is a key reason why the S&P 500 is considered a better way to track the market than the Dow Jones. The SPDR S&P 500 ETF (SPY 0.95%) is the exchange-traded fund (ETF) for tracking the S&P 500 index. Indeed, it is one of the oldest ETFs in existence.

However, there are still some potential pitfalls involved in investing in a product that tracks the S&P 500 index, as the most popular stocks tend to be the largest stocks. This may feel good when Wall Street is on its way, but it can lead to additional pain when a bull market turns into a bear market.

Why the Invesco S&P 500 Equal Weight ETF is attractive now

The market goes up and down — that’s how Wall Street works. And usually when the market goes up a lot, there is an excess of enthusiasm that will eventually be washed away by a correction (a market decline of 10% or more from the peak) or, worse, a market bear (a market decline of 20% or more). Right now, the stock market is nearing all-time highs, but a small number of megacap companies are driving much of the market’s movement. There is one way to soften the blow that this is likely to have in a market downturn — equal weighting. This is the methodology used by the Invesco S&P 500 Equal Weight ETF.

It essentially takes the same list of stocks that are in the S&P 500, but assigns them all the same dollar investment, then periodically rebalances its portfolio to bring each company’s share of the total back to parity. This means that stock movements of the largest companies in the index have the same impact on its performance as the smallest companies. That makes a big difference, especially at times like these, as the chart below highlights. Notice how the Invesco Equal Weight ETF lags the Market Cap Weighted ETF.

SPY Total Return Price data by YCharts.

Consider in particular how the S&P 500’s total return, which assumes dividend reinvestment, has taken off over the past year or so. This is basically when the so-called “Magnificent Seven” stocks started to be the main driver of the movements of the general market index. Yes, it’s good to own those stocks through a market cap-weighted index when they’re rising sharply, but in a bear market, those types of stocks are often the ones that fall the hardest. If this happens, it will be much better to be invested in an index that holds shares of the same companies, but with equal weighting, because sharp declines in a small number of them will not have such a painful impact on returns your.

SPY Total Return Price data by YCharts.

In fact, the declines in those stocks may even be somewhat offset by the fact that during market corrections, investors tend to flock to stocks considered safe havens, such as utilities and consumer staples. Because the movements of those stocks will have the same impact on the performance of an equal weight index as all others, they can help soften the blow of stocks that might implode. If you’re wondering how useful this can be, notice in the chart above that the Invesco S&P 500 Equal Weight ETF has outperformed the S&P 500 over a 20-year period.

Prepare for the worst today

That doesn’t mean you should put all your money in the Invesco S&P 500 Equal Weight ETF. However, it might be a good idea to hedge your bets a bit if you have a large portion of your portfolio in market-cap-weighted funds, such as the SPDR S&P 500 ETF. That way, when the bad times finally come — and they will eventually, if history is any guide — you won’t have to bear the brunt of the pain that’s likely to set in thanks to the small number of hotties. stocks lead the market higher.