Weighted Funds Can Inadvertently Open Investors to Risk

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[dropcap]M[/dropcap]arket cap weighting can result in unintended risks. Even if an investor thought they were purchasing the market through an S&P 500 index fund, by definition they would be overweight to the largest stocks. But just because they are the largest stocks it doesn’t mean they will perform the best. Cap weighting can also result in sector risks. An S&P 500 index fund in 1999 would have significant exposure to technology stocks, while the same fund in 2006 would have a large weight in financials. Both sectors experienced significant downturns in the subsequent years, subjecting “passive index” investors to large losses. Equal weighting size and sectors can help mitigate these risks.

No Lost Decade for S&P 500 as Market Value Bias Masks Rally

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