Investing in exchange traded funds (ETFs) used to be simple. Investors picked one that mimicked the S&P 500 and received a fund that often beat most actively-managed funds. However, as more ETFs and indexes are created, ETF investing has become more complicated.

For example, it used to be that all indexes were market-cap weighted, which is considered the traditional approach to indexing. It’s calculated by multiplying the stocks’ quoted price by the number of shares outstanding, which means it tends to favor larger companies and growth stocks, according to Janice Fioravante for The Christian Science Monitor. Today, fundamental indexing has created competition for the traditional approach. This strategy tends to favor smaller companies and value stocks. Another approach is an index that equally weighs all the companies within it. An example of an ETF that tracks this type of fundamental index is the Rydex S&P Equal Weight (RSP).

Other versions using the fundamental indexing-approach include the Research Associates Fundamental Index (RAFI) index and the dividend index. The RAFI index uses sales, dividends, earnings and book value to weigh its holdings. As imagined, the dividend index is based on holdings’ dividends and earnings. 

Read the full disclosure, as Tom Lydon is a board member of Rydex Investments.

Tags: Dividend ETFs