Different Ways Index Funds Are Weighted

You invest in index funds, but do you know that different index funds are weighted in a different way? Whatever type of index fund or funds you choose, make sure you understand the methodology, so you can stay away from an investment that doesn't behave the way you expected.

Although index funds seem to track anything and everything, there are a few primary ways of constructing them, from conventional market-cap weighting to alternative methods such as equal, fundamental, or price weighting. (read full article "How Index Funds Are Weighted" on SmartInMoney.com)

Cap-Weighted Indexing
By far the most common method of indexing is through market-cap weighting, in which the amount of each stock held is proportionate to its market value, or capitalization. So if a stock's market cap makes up 6% of an index, it also makes up 6% of the fund's portfolio.

Equal-Weighted Indexing
All stocks are held in equal proportion regardless of market cap. So, for example, an equal-weighted S&P 500 fund would still include the same 500 stocks as the cap-weighted version, but in equal amounts--in this case each making up 0.2% of the index.

Fundamental Indexing
Stocks are weighted based on a fundamental metric or metrics, such as dividend yield, earnings, book value, or a combination of factors.

Price-Weighted Indexing
Stocks are weighted by the share price for each company in the index, with the Dow Jones Industrial Average the most famous example.

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