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This is an inherent property of all market cap weighted indexes. An alternative approach is equal weighted indexes, which have historically outperformed market

This is an inherent property of all market cap weighted indexes. An alternative approach is equal weighted indexes, which have historically outperformed market cap weighted indexes. There's no free lunch though: this is a case of your typical risk/reward tradeoff. Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. Some of them feature equal weighting across industry sectors as well as amongst separate companies. Here's an example of one (also note the high fees): https://www.guggenheiminvestments.com/etf/fund/rsp-guggenheim-sp-500-equal-weight-etf https://www.guggenheiminvestments.com/etf/fund/rsp-guggenhei... I personally just stick with VTI and VXUS for stocks (excluding my Airbnb & other startup shares), but I also have about 50% of my net worth in crypto (and I remain bullish).

hendzen 9y ago
What you want is an equal risk weighted SPY ETF - where each component is weighted such that the contribution to total volatility is equalized. This can be done using some off the shelf risk models from firms like MSCI. There was such an ETF (ERW), but it never really took off, and it no longer trades. Unfortunately these methods will just remain available to only more sophisticated market participants.
- brndnmtthws 9y ago
  There's still a lot of opportunity for new types of passive index funds, using methods like you suggest. Maybe someone will start an up.
  - pedrocr 9y ago
    That's stretching the definition of passive investing. What the OP describes is an active strategy like any other. That you can automate it and wrap it in an ETF doesn't make it passive.
  - matt_wulfeck 9y ago
    My hunch tells me specialized funds won’t beat cap weighted indexes from places such as Vanguard because of fees.
em3rgent0rdr 9y ago
If you want to avoid the large cap companies but still want to use index funds, could simply buy mid & small cap index funds [1]. Of course more risk with smaller caps. [1] such as ones based on the Dow Jones U.S. Completion Total Stock Market Index which holds the 500th to 5000th largest companies
ericjang 9y ago
Why are you so bullish in crypto? Would love to hear your thoughts here (or send me a DM if you prefer).
- brndnmtthws 9y ago
  I usually direct people who ask about this toward Andreas Antonopoulos and Tom Lee (of Fundstrat). Bitcoin's value seems to mimic that of social networks, which suggests that Metcalfe's law applies. I don't trust governments, especially in the US where we have rampant crony capitalism, and I'm anti-borders, anti-military, and anti-authoritarianism. There's plenty of good information on Reddit (/r/Bitcoin is pretty good, /r/btc is more like InfoWars), but of course you need to be able to wade through the BS. I'm a Bitcoin maximalist (and have about 80% of my holdings in Bitcoin), with some ETH and LTC, and a long list of alts that I think might have potential. I also don't recommend investing in Bitcoin (or any other cryptocurrency) unless you have a high tolerance for risk and can afford to lose it. Here's an aantonop playlist if you want to binge: https://www.youtube.com/playlist?list=PLPQwGV1aLnTthcG265_FYSaV24hFScvC0 https://www.youtube.com/playlist?list=PLPQwGV1aLnTthcG265_FY...
uiri 9y ago
When it comes to an index like the S&P 500 where even some of the smaller components (e.g. Church & Dwight Co (read: Arm & Hammer), Hilton, etc) would be considered "large cap" then you probably want to do equal weighting rather than market cap weighting. When it comes to something like Vanguard's Total Market, you probably want to put more money into the blue chip stocks than into the smaller companies at the bottom of the list (sorted by market cap). Smaller companies have lower trade volume/are less liquid which makes them subject to greater volatility/price fluctuations. There is no sense taking on greater risk there when the reward opportunity doesn't meaningfully increase with it.
pedrocr 9y ago
>Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. But do they outperform after risk adjustment? I doubt it and if not you're better off just leveraging a bit to your desired level of risk. The point of passive investing isn't that the trading strategy can be automated, the point is to say "I want to grab exactly the average return of the market every year". Trying to do anything else is by definition not achievable by everyone so why do people think they should be the lucky ones? What specific advantage does a retail investor bring to merit that?
- perl4ever 9y ago
  I don't think it makes sense to equate risk with volatility. Say I have $1M. If I buy a cap weighted S&P 500 fund, I have about $40,000 in Apple, because it's about 4%. If I then switch to an equal weighted S&P 500, that $40K will be split up between 20 stocks with about $2K each. That is clearly more diversified with respect to company specific risk. It may or may not be worth it given increased fees, but you can't just dogmatically say it's equivalent to cap-weighted plus leverage. It's qualitatively different.
  - ataturk 9y ago
    The S&P fund or any index that spreads out your risk is pretty much always your best bet. If you hold a single stock, say AAPL, and that one stock slides for any reason, you don't have enough years to make it all back. We regular folk who do not buy options as insurance can only spread out our risk as widely as possible. Institutions and firms with billions of dollars can do fancy things to protect themselves.
  - pedrocr 9y ago
    >you can't just dogmatically say it's equivalent to cap-weighted plus leverage I'm saying it's strictly better to do cap-weighted plus leverage. That's what financial theory tells us anyway, that the best portfolio is whatever mix between risk free cash and the same mix as all the assets in the world. Deviating from that brings you farther away from the efficiency frontier. Now for this to hold EMH must hold and we know it's not true in the stronger forms which was why I was asking for a risk adjusted benchmark.
harrisjt 9y ago
50% in crypto? Good luck man, that sounds very risky.
- mitchdoogle 9y ago
  It could easily have started out as 5% in crypto a year ago and just recently grew to be 50%.
  - brndnmtthws 9y ago
    Closer to this, but with different numbers.
  - brokensegue 9y ago
    doesnt change how risky it is

hendzen 9y ago

What you want is an equal risk weighted SPY ETF - where each component is weighted such that the contribution to total volatility is equalized. This can be done using some off the shelf risk models from firms like MSCI. There was such an ETF (ERW), but it never really took off, and it no longer trades. Unfortunately these methods will just remain available to only more sophisticated market participants.

brndnmtthws 9y ago
There's still a lot of opportunity for new types of passive index funds, using methods like you suggest. Maybe someone will start an up.
- pedrocr 9y ago
  That's stretching the definition of passive investing. What the OP describes is an active strategy like any other. That you can automate it and wrap it in an ETF doesn't make it passive.
- matt_wulfeck 9y ago
  My hunch tells me specialized funds won’t beat cap weighted indexes from places such as Vanguard because of fees.

em3rgent0rdr 9y ago

If you want to avoid the large cap companies but still want to use index funds, could simply buy mid & small cap index funds [1]. Of course more risk with smaller caps. [1] such as ones based on the Dow Jones U.S. Completion Total Stock Market Index which holds the 500th to 5000th largest companies

ericjang 9y ago

Why are you so bullish in crypto? Would love to hear your thoughts here (or send me a DM if you prefer).

brndnmtthws 9y ago
I usually direct people who ask about this toward Andreas Antonopoulos and Tom Lee (of Fundstrat). Bitcoin's value seems to mimic that of social networks, which suggests that Metcalfe's law applies. I don't trust governments, especially in the US where we have rampant crony capitalism, and I'm anti-borders, anti-military, and anti-authoritarianism. There's plenty of good information on Reddit (/r/Bitcoin is pretty good, /r/btc is more like InfoWars), but of course you need to be able to wade through the BS. I'm a Bitcoin maximalist (and have about 80% of my holdings in Bitcoin), with some ETH and LTC, and a long list of alts that I think might have potential. I also don't recommend investing in Bitcoin (or any other cryptocurrency) unless you have a high tolerance for risk and can afford to lose it. Here's an aantonop playlist if you want to binge: https://www.youtube.com/playlist?list=PLPQwGV1aLnTthcG265_FYSaV24hFScvC0 https://www.youtube.com/playlist?list=PLPQwGV1aLnTthcG265_FY...

uiri 9y ago

When it comes to an index like the S&P 500 where even some of the smaller components (e.g. Church & Dwight Co (read: Arm & Hammer), Hilton, etc) would be considered "large cap" then you probably want to do equal weighting rather than market cap weighting. When it comes to something like Vanguard's Total Market, you probably want to put more money into the blue chip stocks than into the smaller companies at the bottom of the list (sorted by market cap). Smaller companies have lower trade volume/are less liquid which makes them subject to greater volatility/price fluctuations. There is no sense taking on greater risk there when the reward opportunity doesn't meaningfully increase with it.

pedrocr 9y ago

>Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. But do they outperform after risk adjustment? I doubt it and if not you're better off just leveraging a bit to your desired level of risk. The point of passive investing isn't that the trading strategy can be automated, the point is to say "I want to grab exactly the average return of the market every year". Trying to do anything else is by definition not achievable by everyone so why do people think they should be the lucky ones? What specific advantage does a retail investor bring to merit that?

perl4ever 9y ago
I don't think it makes sense to equate risk with volatility. Say I have $1M. If I buy a cap weighted S&P 500 fund, I have about $40,000 in Apple, because it's about 4%. If I then switch to an equal weighted S&P 500, that $40K will be split up between 20 stocks with about $2K each. That is clearly more diversified with respect to company specific risk. It may or may not be worth it given increased fees, but you can't just dogmatically say it's equivalent to cap-weighted plus leverage. It's qualitatively different.
- ataturk 9y ago
  The S&P fund or any index that spreads out your risk is pretty much always your best bet. If you hold a single stock, say AAPL, and that one stock slides for any reason, you don't have enough years to make it all back. We regular folk who do not buy options as insurance can only spread out our risk as widely as possible. Institutions and firms with billions of dollars can do fancy things to protect themselves.
- pedrocr 9y ago
  >you can't just dogmatically say it's equivalent to cap-weighted plus leverage I'm saying it's strictly better to do cap-weighted plus leverage. That's what financial theory tells us anyway, that the best portfolio is whatever mix between risk free cash and the same mix as all the assets in the world. Deviating from that brings you farther away from the efficiency frontier. Now for this to hold EMH must hold and we know it's not true in the stronger forms which was why I was asking for a risk adjusted benchmark.

harrisjt 9y ago

50% in crypto? Good luck man, that sounds very risky.

mitchdoogle 9y ago
It could easily have started out as 5% in crypto a year ago and just recently grew to be 50%.
- brndnmtthws 9y ago
  Closer to this, but with different numbers.
- brokensegue 9y ago
  doesnt change how risky it is