3 Reasons to Buy Invesco S&P 500 Equal Weight ETF Like There's No Tomorrow

Key Points

• The S&P 500 index is market-cap-weighted, meaning the largest stocks have the biggest impact on performance.

• Invesco S&P 500 Equal Weight ETF uses an equal-weighting methodology, which means all stocks have the same impact on performance.

• Although Invesco S&P 500 Equal Weight ETF can lag the S&P 500 at times, it may be a safer alternative in today's market.

• 10 stocks we like better than Invesco S&P 500 Equal Weight ETF ›

The biggest reason to buy Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) is contained in the exchange traded fund's (ETF) name. That said, there's more to the story here than meets the eye. Here are three reasons why, if you are considering buying an S&P 500 (SNPINDEX: ^GSPC) index clone, you might be better off buying this Invesco ETF like there's no tomorrow instead.

1. Equal weighting matters theoretically and practically

The S&P 500 index is constructed by a committee. It includes 500 or so of the largest and most economically important U.S. companies, picked using specific criteria. The stocks that make the list are weighted by market cap, so the largest companies have the biggest impact on the index's performance. It is a well-constructed index that does a good job of tracking the U.S. economy and, secondarily, the U.S. stock market.

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If you look at the past decade, the S&P 500 index has easily outdistanced Invesco S&P 500 Equal Weight ETF. But if you look back to roughly the inception of Invesco S&P 500 Equal Weight ETF, it has actually beaten the S&P 500 index on both price-only performance and total return, which assumes dividend reinvestment. There's clearly something going on here, noting that Invesco S&P 500 Equal Weight ETF's 0.2% expense ratio is actually kind of high for an exchange-traded fund.

Using equal weighting makes a performance difference over time. The key is that equal weighting means every stock has the same impact on performance, good and bad. So the upside is limited from large companies today, but so will be the downside when today's hot stocks slump. Effectively, equal weighting increases diversification while market-cap weighting leads to heavy concentrations in hot stocks.

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If you are a long-term investor and want to be in the market, but are worried about the frequent excesses of the market, the Invesco S&P 500 Equal Weight ETF will be a great pick for you despite the elevated expense ratio.

2. The ETF's valuation levels are extreme right now

The first point is a big-picture view of things. Getting down to something a little more specific to today, Invesco S&P 500 Equal Weight ETF's valuation levels are way more attractive than those of the S&P 500 index.

The S&P 500 index's average price-to-earnings ratio is currently around 27.6. The price-to-book value ratio is 5. Alone, those numbers don't mean much. The importance shows up when you compare them to Invesco S&P 500 Equal Weight's 19.3 P/E ratio and 2.9 P/B ratio. The S&P 500 is expensive right now, as its performance has been driven by a small number of very large technology stocks. Invesco S&P 500 Equal Weight ETF isn't nearly as expensive, which positions it better when those tech giants falter.

3. Technology is less than half as important for this ETF

The final reason to buy the Invesco S&P 500 Equal Weight ETF is very granular and it goes back to the technology sector. The S&P 500 index's weighting in technology is roughly 34% today. Step back and think about that for a second. If you buy the S&P 500, you are putting a third of your portfolio in technology stocks. That's a very heavy weighting, or, to think of it another way, a very big bet on technology stocks. This is the kind of imbalance that market cap weighting leads to.

The Invesco S&P 500 ETF's weighting in technology stocks is only about 14%, less than half as much exposure to a sector that is hot right now. But Wall Street history tells investors that hot sectors eventually cool off. There's another number to look at here, though.

Nine of the top 10 holdings in the S&P 500 index are technology-related, if not directly in the tech sector. These top 10 holdings account for nearly 39% of assets. Invesco S&P 500 Equal Weight ETF's top-10 list contains a mix of industries and only accounts for about 3% of the ETF's assets. This all goes back to the equal-weighting methodology, but the difference is clearly important and pervasive when it comes to what you are buying.

Invesco S&P 500 Equal Weight is hidden in plain sight

Invesco S&P 500 Equal Weight ETF is a unique way to get exposure to the broader market. What it does isn't rocket science; it is a pretty simple approach to investing. But history suggests equal weighting works and that it leads to a materially different portfolio than you would get if you'd just bought an S&P 500 index ETF. If you are a long-term investor, going with Invesco S&P 500 Equal Weight ETF could be a very wise choice as the S&P 500 rockets higher on the backs of a very small number of large stocks.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.