Capitalization-Weighted Index

If you have investments in any indexes (or, indices, if you prefer), time to listen up, because most indexes on the market today are capitalization weighted.

Capitalization weighted indexes are market indexes that have elements that are kept in proportion to their market capitalization. Let’s break that down.

You’ve heard of these: the S&P 500, the Nasdaq Composite. These indexes are weighted, meaning all the goodies inside them aren’t equally represented. Which is good, right? If Apple, Google, and Microsoft make up a large part of a tech-index, then you’d want to be more invested in them than equally invested in some tiny tech start-up that...might not make it.

Finding the value of a cap-weighted index is pretty straightforward. Just take the total shares x the price per share to get the market value, then compare market values.

For instance, if there was a two-stock index (hopefully not in real life) with company A having 100 stocks at $1 each and company B having 50 stocks at $5 each, that would mean A has a market value of $100 and B of $250. These companies will be proportionally represented in the index, so you’ll be more invested in B than A by 2.5x.

Makes sense...so why is this so important to know? Well, it means that, if there’s volatility among the big boys, the index you’re invested in will feel more like you put all your eggs in one basket rather than many. And if you’re invested in an index, it’s probably because you wanted some variety in your life, for risk’s sake. It also means that, if one company grows super fast, they may be suddenly taking up a huge amount of an index by weight, distorting the market...and maybe your investments in a sense, too.

The lesson: your index might not always be as varied and safe as you think it is. So wear protective gear and brace for impact.