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The standard Standard & Poor’s 500 is capitalization-weighted; that is, each stock’s percentage of the index is based on its market capitalization. The other S&P 500 is equal-weighted; that is, each stock has the same percentage of the index so no stock dominates the index’s influence. Is this good?

Not bad, so far.

In 2009, the equal-weighted S&P 500 is up 17% while the cap-weighted index is up about 5.5%.
From 1990 through June, 2009, the equal-weighted index was up 9.1% vs. 7.5% for the cap-weighted index.

Disadvantages

There are some caveats with equal-weighted index:

1. Higher transaction costs.

The equal weight indexes are rebalanced every quarter (which adds to higher cost) whereas the cap-weighted index requires balancing only if the stocks of the S&P 500 index changes.

2. More volatile. This is primarily due to the propensity of smaller companies to be more volatile than larger. Since there is equal weighing, the small company volatility is amplified.

3. The dividend yield tends to be smaller than the cap-weighted index.

All is not perfect. In 2007 and 2008 the equal-weight index performed worse than the cap-weighted version.

Indexes

RSP – Rydex S&P Equal Weight Index (ETF). Replicates the S&P 500 Equal Weight Index. Inception date: May, 2003. 0.40% expense ratio.

SPY – Cap-weighted S&P 500 Index (ETF). Replicates the S&P 500 Capitalization Weighted Index. 0.10% expense ratio.

There are a few mutual funds that emulate the equal weight index but their expense ratios are more than 1.00% which is outrageous for an index.

As usual, this article is for informational use only.