How Indexes Are Weighted
Do big and small companies carry the same clout in an index? Compare cap-weighted and equal-weighted to see who moves the index.
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Text version · Indexes & ETFs, lesson 2: “How Indexes Are Weighted”
Do big and small companies carry the same clout in an index? Compare cap-weighted and equal-weighted to see who moves the index.
Cap-weighted: the giants call the shots
A cap-weighted index sizes each company by market cap: the bigger the company, the bigger its weight, so a few giants can sway the whole index.
Equal-weighted: one company, one vote
An equal-weighted index ignores company size and gives every constituent the same weight. With 5 stocks at 20% each, small companies get a louder voice.
Only the freely tradable part counts
Many indexes weight by free-float market cap: shares that insiders hold long-term or that are locked up can't be bought on the market, so they don't count toward the weight. Equal-weighted indexes have to rebalance regularly, trimming the big gainers and topping up the laggards.
Key takeaways
- Cap-weighted: the bigger the company's market cap, the bigger its weight (e.g. the S&P 500). Many indexes use free-float market cap.
- Equal-weighted: every constituent has the same weight, which amplifies small companies; it must be rebalanced back to equal weights regularly.
- Index change ≈ the sum of (weight × change) across constituents, so cap-weighted indexes are often dominated by a few giants.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click "Example": a giant with 30% weight rises 10% and nothing else moves. How much does the cap-weighted index rise? And the equal-weighted one?
- Drag the giant to −20%: how much does each index fall?
- Reset the giant to zero and push Ming's Coffee (only 5% when cap-weighted) to +20%: which index is affected more?
- Click "Giant down · small up": why do the two indexes move in opposite directions on the same day?
Quiz and explanations
- 1. In a cap-weighted index, a giant with a 30% weight rises 10% and nothing else moves. Roughly how much does the index rise?
- Answer: 3%.30% × 10% = 3%.
- 2. In an equal-weighted index, each stock's weight is…
- Answer: The same.Equal-weighted = split evenly.
- 3. An index is 60% stock A and 40% stock B. Today A falls 5% and B rises 10%. Roughly how does the index move?
- Answer: +1%.60% × (−5%) + 40% × 10% = −3% + 4% = +1%.
Terms in this lesson
- cap-weighted (Cap-Weighted): Weights are set by each constituent's market cap: the bigger the company, the more it moves the index.
- equal-weighted (Equal-Weighted): Every constituent gets the same weight, no matter how big the company is.
- free-float market cap (Free-Float Market Cap): Market cap excluding shares that don't trade, such as long-held stakes and locked-up shares; many indices weight by it instead of total market cap.
- market cap (Market Cap): Share price × total shares: what the market thinks the whole company is worth.