What is an equal-weight vs. market-cap-weighted investment strategy?

What is an equal-weight vs. market-cap-weighted investment strategy?

When investing in a stock index, the way stocks are weighted affects your returns.
The two main strategies are Market-Cap Weighting and Equal-Weighting.

Market-Cap Weighted Strategy

This strategy gives more weight to bigger companies based on their total market value.

How does the Market-Cap Weighted Strategy Work?

  1. Large and well established companies have a bigger impact on the stock market index.
  2. If the big company's stock rises or falls, the whole index moves significantly.
Example: NIFTY50 and SENSEX follow market-cap weighting.

Pros of Market-Cap Weighted Strategy

  1. Lower trading costs.
  2. Follows market trends and large-cap stability.

Cons of Market-Cap Weighted Strategy

  1. Over-dependence on a few large companies.
  2. Small stocks don't contribute much, even if they perform well.

Equal-Weight Strategy

This strategy gives equal importance to every stock, no matter its size.

How does the Equal-Weight Strategy Work?

  1. Every company gets the same weightage, whether big or small.
Example: If applied to NIFTY50, every stock would have 2% weight, rather than large cap dominating.

Pros of Equal-Weight Strategy

  1. More diversified since small and mid-sized companies have equal say.
  2. Can outperform in bull markets, as smaller stocks hold the potential to grow faster.

Cons of Equal-Weight Strategy

  1. Higher trading costs and frequent rebalancing.
  2. Riskier if small stocks underperform.

Which Strategy is Better?

  1. Market Cap Weighted Strategy: Better for stability and lower costs, follows overall market trends.
  2. Equal-Weight Strategy: More diversification, higher potential returns in a bull market, but can be riskier.
Both strategies have their place, depending on your risk appetite and market conditions.

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