When it comes to exchange traded fund (ETF) investing, did you know that different indexing strategies can either make or break your success? Click through to read about the different types and how they can affect you.
Most ETFs passively track indexes, and those indexes generally have a strategy as to how its components are weighted. “Weighting” refers to the way stocks are distributed within a portfolio, Ron Rowland for Money and Market explains. For example, in one index, a company might make up 10% of the overall portfolio while in another index that’s constructed differently, the same company could make up just 1% of the portfolio.
Providers of ETFs have developed alternative weighting schemes that can be useful, especially if there is reason to believe that certain companies are going to outperform others. Here is a rundown:
Equal weight: This is a simple approach – divide the money between all the stocks weighted within the index equally. If an index has 50 stocks, each one represents 2%.
Dividend & Earnings Weighted: WisdomTree is the master of this method. These are for income-loving investors who want to own companies that have a record of growing their dividends. The indexes are measured, or weighted, by fundamental factors such as dividends and earnings. The provider says that this method can lead to better long-term results.
Revenue Weighted: Simply put, stocks within the index are weighted according to revenue. Over time, the results should yield good returns.
- RevenueShares Small Caps (NYSEArca: RWJ)
Fundamentally Weighted: A number of factors go into fundamental weighting, including book values, sales, dividends and cash flow.
- PowerShares FTSE RAFI US 1000 (NYSEArca: PRF)
- PowerShares FTSE RAFI Emerging Markets (NYSEArca: PXH)
For more stories about indexing, visit our indexing category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.