Equal Weighted vs Market Cap Weighted
Two common portfolio weighting schemes; equal weight often tilts toward smaller names and can improve diversification.
Definition
- Market cap weighted: Each asset’s weight is proportional to its market capitalization. Large caps dominate (e.g. S&P 500).
- Equal weighted: Each asset has the same weight (1/N). Small and mid caps have the same weight as large caps.
Why it matters
- Concentration: Cap-weighted portfolios are concentrated in the largest names; equal weight spreads exposure.
- Size tilt: Equal weight tilts toward smaller names, which historically have had different return and vol characteristics.
- Rebalancing: Equal weight requires periodic rebalancing (selling winners, buying losers), which can add a rebalancing premium or cost depending on implementation.
Trade-offs
- Cap weighted: Low turnover, cheap to implement (e.g. index funds); concentration and momentum bias.
- Equal weighted: More diversification by name; higher turnover and potentially higher costs; small-cap tilt.
Linked concepts
Position sizing, MPT, hierarchical risk parity, rebalancing.