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If you’re interested in learning the difference between cap weighted and equal weighted we have a great analogy that’ll help simplify things. Our friends from Dorsey Wright & Associates came up with this analogy and we thought it was really cool, so we featured it on this week’s Mullooly Asset Management podcast.
We still get a lot of questions from people who don’t totally understand the difference between cap weighted and equal weighted. Sometimes the best way to describe something is through analogy. So what can the structure of Congress teach us about stock weightings? To put it simply, think of the House of Representatives as cap weighted and Senate as equal weighted. We’ll get into a little more detail on why that is below.
The House of Representatives has 435 members total. The number of representatives from each state is determined by population. This is similar to being cap weighted, where stocks with the largest market capitalization receive the largest weighting. For example, the United States had a population of 313 million people in 2012. California accounted for 38 million of those people or 12%. That means that California gets 53 of the 435 seats in the House of Representatives. States like Alaska, Vermont, Wyoming, and the Dakotas only get one seat a piece. This is a lot like how Apple gets the largest weighting in the S&P 500, while companies like Cablevision receive hardly any weight at all.
Senate illustrates a more equal weighted approach in this analogy. In the US Senate, each state gets the same number of votes regardless of their population. There are 100 seats and each state gets 2. That means every state, whether we’re talking about Texas or Rhode Island, makes up 2% of the Senate. To relate things back to the market, this is like the equal weighted S&P 500. It has the same 500 stocks as the cap weighted S&P 500. Instead of Apple getting the largest weighting, all 500 stocks have the same 0.20% weight.
We bet you never thought Congress would teach you anything about the stock market! Again, awesome work by Dorsey Wright & Associates for coming up with this analogy. We hope that it helps you to better understand the differences between cap weighted and equal weighted.
Make sure you listen to this week’s podcast to hear the full explanation from Tom and Brendan!
**Note** Population numbers taken from census.gov