The Advantages of Equal-Weighted ETFs over Market-Cap Weighted

4 June 2025

Investing in exchange-traded funds (ETFs) has become one of the most popular ways to build wealth. But did you know that not all ETFs are created equal? Most investors are familiar with market-cap-weighted ETFs, but equal-weighted ETFs offer some unique advantages that can enhance your portfolio.

So, what makes equal-weighted ETFs stand out? And why might they be a better choice for certain investors? Let’s break it down in simple terms.

Understanding Market-Cap and Equal-Weighted ETFs

Before we dive into the advantages of equal-weighted ETFs, let's first understand the difference between these two types.

Market-Cap Weighted ETFs

Market-cap-weighted ETFs allocate more weight to larger companies. In other words, if a company has a higher market capitalization (stock price × number of outstanding shares), it will have more influence on the ETF’s performance.

For example, in an S&P 500 market-cap-weighted ETF, big names like Apple, Microsoft, and Amazon dominate the fund. Their stock price movements significantly impact the overall performance of the ETF.

Equal-Weighted ETFs

On the other hand, equal-weighted ETFs give the same amount of importance to every stock in the index, regardless of company size. Whether it’s a giant like Apple or a smaller company like Etsy, each stock holds the same percentage within the fund.

This simple tweak can make a huge difference in investment strategies and performance.

Why Equal-Weighted ETFs Have the Edge

Now that we’ve covered the basics, let’s look at why equal-weighted ETFs can be a smarter choice compared to their market-cap-weighted counterparts.

1. Greater Diversification

One of the biggest perks of equal-weighted ETFs is better diversification.

In a market-cap-weighted ETF, a few giant companies dominate the fund. If those companies perform poorly, your returns take a big hit. With an equal-weighted ETF, every stock has the same influence, spreading risk more evenly across the board.

Think of it like a dinner party—if you only serve one dish, and it turns out bad, the whole meal is ruined. But if you have multiple dishes, a single bad choice won’t spoil the entire experience.

2. Reduced Concentration Risk

Market-cap-weighted ETFs are often top-heavy, meaning the largest companies hold too much power over performance. This can create concentration risk—a situation where your investments rely too much on a few dominant stocks.

For instance, in an S&P 500 market-cap ETF, the top 10 companies can make up nearly 30% of the entire fund! That’s a lot of weight on a handful of stocks. If those companies struggle, your portfolio could take a hit.

Equal weighting spreads out the risk. Since every stock has the same influence, poor performance from a few major players won’t drastically impact the fund.

3. Stronger Performance in the Long Run

Historically, equal-weighted ETFs have outperformed market-cap-weighted ETFs over the long term. This is because they naturally follow a “buy low, sell high” approach.

Here’s how:

- When a stock price rises significantly, an equal-weighted ETF will trim that position during rebalancing to maintain equal allocation.
- When a stock’s price drops, the ETF buys more shares, ensuring an even balance.

This rebalancing helps avoid overexposure to overvalued stocks while capturing growth from undervalued ones. Studies have shown that equal-weighted strategies often generate higher returns over extended periods.

4. More Exposure to Smaller Companies

Market-cap-weighted ETFs heavily favor large-cap stocks. This means smaller companies, which often have higher growth potential, don’t get much attention.

Equal-weighted ETFs level the playing field, providing more exposure to mid-cap and small-cap stocks. These companies can sometimes outperform large-cap stocks, especially in strong economic cycles.

It’s like betting on an underdog team that has the potential to surprise everyone—sometimes, they deliver bigger wins.

5. Natural Mean Reversion Benefit

Equal-weighted ETFs take advantage of a well-known phenomenon in investing: mean reversion. This means that stock prices tend to revert to their average over time.

Since equal-weighted ETFs regularly rebalance, they automatically sell high-performing stocks and buy underperforming ones. This disciplined approach can lead to better long-term returns, as it helps capture gains from stocks that rebound after lagging.

Think of it like a thermostat—if things get too hot, it cools down, and if they get too cold, it warms up, keeping everything in balance.

The Potential Downsides of Equal-Weighted ETFs

While equal-weighted ETFs have many benefits, they’re not perfect. Here are some potential drawbacks to consider:

1. Higher Turnover = Higher Costs

Since equal-weighted ETFs need frequent rebalancing, they can have higher transaction costs compared to market-cap-weighted ETFs. These costs may lead to slightly higher expense ratios.

2. Increased Volatility

Because equal-weighted ETFs give more weight to smaller companies, they can be more volatile. While this can lead to higher returns in bull markets, it can also mean steeper declines during downturns.

3. Less Tax Efficiency

Frequent rebalancing may trigger more capital gains taxes, making equal-weighted ETFs potentially less tax-efficient compared to market-cap-weighted ETFs.

When Should You Consider Equal-Weighted ETFs?

So, should you switch to equal-weighted ETFs? It depends on your investing style and goals.

Equal-weighted ETFs might be a great choice if:

✅ You want better diversification and reduced concentration risk.
✅ You’re looking for long-term outperformance.
✅ You're comfortable with slightly higher volatility.
✅ You believe small and mid-cap stocks have higher growth potential.

However, if you prefer lower costs, tax efficiency, and a simple "buy and hold" strategy, market-cap-weighted ETFs may still be the better fit.

Conclusion

Equal-weighted ETFs offer a compelling alternative to traditional market-cap-weighted funds. By spreading investments evenly, they provide better diversification, reduce risk, and often deliver stronger performance over the long run.

That said, they do come with trade-offs, like higher costs and potential volatility. As with any investment, it’s important to assess your risk tolerance and investment strategy before making the switch.

At the end of the day, there’s no “one-size-fits-all” approach in investing. But if you’re looking for a strategy that avoids concentration risk and takes advantage of market trends, equal-weighted ETFs might just be the secret weapon your portfolio needs.