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January 28, 2004
Which S&P Index is Correct?
What is the best way to measure an equity index's movements, capitalization-weighted or equally-weighted? As the Wall Street Journal points out this morning, the former method is common and showed a loss on the S&P 500 over the last three years; the latter method is less common and showed a gain.
The answer, of course, is it depends. Both equally-weighted and cap-weighted indices can be useful, so it is good to look at both. While the latter is skewed by large-cap stocks, as happened in the late 1990s, it also underweights the performance of small-caps. Equal-weighted indices solve that problem, while creating the new problem of implicitly goading people into investing in smaller and less liquid stocks, which is also unrealistic.
The upshot: Nothing is perfect -- look at both.
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