ETFs
Forget the Dow Jones: buy this magnificent ETF instead
With a single investment, you can get a portfolio with roughly equal positions in about 500 of the largest U.S. companies.
THE Dow Jones Transportation Average and the Dow Jones Industrial Average are two of the oldest stock tracking indices still in use today. Their longevity shows how important following market trends is for many investors.
However, despite their history, these Dow Jones indices have some limitations compared to the overall market. First and foremost, they only follow a handful of companies. The Dow Industrials covers 30 stocks, while the Transports covers 20. Second, by their nature, they are sector tracking indices, covering “industrial” and “transportation” type companies respectively, rather than the entire market.
Additionally, both are price-weighted indices whose values are based on the market price per share of each of the companies comprising the index. This is a bit problematic, because it means that things like stock splits can significantly change the impact a company can have on an index it’s a part of.
Given these limitations, it may be time to forget about the Dow and consider another ETF instead.
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A wonderful alternative way to index
On this front, the Invesco S&P 500 Equal Weight ETF (RRSP 0.40%) takes a very different approach to indexing, making it a wonderful way to get a large basket of investments in a single purchase. The Invesco S&P 500 Equal Weight ETF starts with the roughly 500 stocks in the S&P 500, then buys a roughly equal stake in each of those companies.
The S&P 500 index covers about 80% of the total market capitalization of U.S. stocks, making it a fairly broad market tracker. By equally weighting (i.e. purchasing the same dollar amounts) the constituents of this index, the Invesco S&P 500 Equal Weight ETF takes this diversification to the next level.
In more traditional ETFs tracking the S&P 500 Index, the ETF will use weighting based on market capitalization, allowing larger companies to account for a larger share of the ETF’s holdings. While this helps these ETFs match the performance of the index, they have a slight disadvantage when it comes to diversification. The top 10 companies — 11 stocks due to one company having two share classes — account for more than a third of the total index value.
By weighting investments equally, the Invesco S&P 500 Equal Weight ETF’s top 10 investments instead represent about 2.5% of the fund’s total value. Although this means that the Invesco S&P 500 Equal Weight ETF will not perfectly match the performance of the S&P500 the index itself, this means that investors are not as tied to the largest companies within it. If you’re investing in an index ETF partly for diversification, it’s a plus for the equal-weighted version of the fund.
Overall, the Invesco S&P 500 Equal Weight ETF has generated annualized returns of around 10% over the past 10 years. Although slightly behind a “standard” S&P 500 index fund over the same period, it is still a reasonable way to make money by owning a broad range of the largest companies in the United States.
Start now
As great as investing can be when it comes to building net worth over time, compounding means that the longer you invest, the better your chances of ending up with a decent-sized nest egg. The sooner you start, the more time you will have to let this composition work its magic.
So make today the day you decide if the Invesco S&P 500 Equal Weight ETF deserves a place in your portfolio. After you’ve established a solid foundation for your investments, you’ll probably be glad you didn’t wait even longer to get started.
Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has no position in any of the securities mentioned. The Mad Motley has a disclosure policy.