There are 3 kinds of weighting in an index fund, and these are:

• Price-Weighted Indices
• Value-Weighted Indices
• Unweighted Indices

Each weighting differs and makes the price of an index fund react differently to one another.

Price-weighted Indices

A price-weighted index fund is based on the stock value of each individual security. Stocks with higher prices will have more influence over stocks with lower prices, regardless of market cap.

“Note: If a stock rises 10% from $400 to $440 this move would have a more significant impact on the index as opposed to a stock which rises 50% from $30 to $45 in the same time period.”

The most popular price-weighted index fund is the Dow Jones Industrial Average (DJIA) which consists of 30 different securities. At current UnitedHealth (NYSE: UNH) has a 9.17% influence on the DJIA whereas Apple (NASDAQ: AAPL) has just a 3.24% influence on the DJIA even though Apple’s market cap is around 6 times larger.

(X-axis Share value in USD)

Value weighted Indices

A value-weighted index fund is based on the number of shares outstanding, (or the total market capitalisation). To calculate a value weight of a stock you first take the price of the stock and multiply it by the number of shares outstanding. This will give you the total market capitalisation which then has an influence on the price of the index fund. The most common Value Weighted Index fund is the S&P 500 which tracks the top 500 companies in the USA. Other common index funds which also follow this same methodology include the FTSE 100 and the NIFTY 50.  

“Example: ABC PLC has 50 million shares outstanding at a value of £100, this would give it a total market value of £5bn. 123 PLC has 10 million shares outstanding at £200, which would give it a market value of £2bn. In the case of a value-weighted index fund, ABC PLC would have a bigger influence on the price of the fund because its market value is more. If it was a price-weighted index fund, the 123 PLC would have a larger influence.”

Taking this weighting model and using the same two companies Apple & UnitedHealth, you’ll now find that when weighted into the S&P 500, Apple has a 7.07% Influence on the S&P500, whereas united health has just a 1.2% influence.

(X-axis market cap in trillions)

Unweighted Indices

An unweighted index can also be known as an equal-weighted index. All securities within this kind of index have an equal impact on a funds price. The price change of the index will also be based on the percentage return of each individual component.

“Example: Assuming there at 4 stocks in an unweighted index, each stock will have an influence of 25%. Stock A is up 10%, Stock B is up 15%, Stock C is down 10% & stock D is up 20%. The formula to calculate this would be A+B+C+D/4 (10+15-10+20)/4 = 8.75%. This means on the day the index would be up 8.75%.”

Having an unweighted index fund will increase diversification while also lowering exposure to risk. Equal weighted funds can appeal to investors because there is much less room for overvalued stocks as it levels out the playing field.  Most major US funds do have an equal-weighted option for investors under specific ETFs.

(X-axis volume weighting)