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Yeah, a lot of people don't realize how market cap weighted actually gets you a not very diversified portfolio. For example, if you hold the S&P 500, about 8% o
by smabie 6y ago
Yeah, a lot of people don't realize how market cap weighted actually gets you a not very diversified portfolio. For example, if you hold the S&P 500, about 8% of that is Apple, 6% is Amazon, 6% Microsoft, and 4% Google.
So 25% of your capital is going to 4 names, all in the same sector. Meanwhile, the smallest holdings will be under 1%.
Though market cap weighted is good for avoiding trading fees (you don't have to rebalance when the price of a stock changes), it's bad for investors. Not only do you miss out on some diversification, you end up with undue exposure to only a few sectors and you miss out on Fama and French's size factor by only investing in large companies.
- hogFeast 6y agoThe size factor has lost money pretty consistently. It is also a very suspicious factor generally because there are very obvious non-risk factor explanations (i.e. liquidity). Just generally, FF do very irrational things with their models (i.e. not including momentum)...they are credible but the way they do things is obviously not quite correct (Fama spent decades saying this kind of thing was totally impossible). Market cap weighting is fine, if you actually end up with something reasonable...which you don't anymore. I wouldn't really recommend equal weighting either...so...