With the S&P 500 at Historically High Levels, This ETF Could Be the Best Way to Invest in the Index

The S&P 500 has long been the stock market’s most followed and important index. Tracking 500 of the largest American companies on the market, it’s often used to gauge the health of the U.S. economy and market. After the index declined by over 19% in 2022, it has experienced a bull run, with its levels increasing by over 68% since the start of 2023. That’s the good news.

The “we should keep an eye on that” news is that now the S&P 500 is trading at historically high levels. Based on its Shiller price-to-earnings (P/E) ratio — which measures stock prices against inflation-adjusted average earnings over the past 10 years — the S&P 500 is trading at levels we haven’t seen in quite some time. And unfortunately, anytime the index has reached these levels, sharp declines soon followed.

S&P 500 Shiller CAPE Ratio data by YCharts

For investors interested in investing in the S&P 500, its extremely high valuation may be alarming. However, there is another way to invest in the index that could possibly hedge against a sudden pullback. And that’s via an S&P 500 equal-weight ETF like the Invesco S&P 500 Equal Weight ETF (RSP -0.07%).

The difference between the standard S&P 500 and equal-weight S&P 500

The standard S&P 500 is weighted by market cap, so larger companies account for more of the index than smaller companies. In the equal-weight S&P 500, each company accounts for roughly the same amount.

Historically, being weighted by market hasn’t been an issue for the S&P 500, but as megacap tech stocks have exploded in valuation over the past couple of years, a handful of companies are now worth a large portion of the index. The Magnificent Seven stocks — Nvidia, Microsoft, Apple, Amazon, Alphabet, Meta, and Tesla — now account for over a third of the index. In the equal-weight S&P 500, they only account for 2.18%.

The high concentration in a handful of tech stocks has worked out well for the S&P 500, given the artificial intelligence (AI)-fueled run they have been on; however, as the saying goes, “the same thing that makes you laugh, makes you cry.” Pullbacks in these stocks, or the tech sector as a whole, will significantly weigh down the index.

Here is how the top 10 holdings of the standard S&P 500 compare between the two:

Sources: Vanguard and Invesco. Vanguard percentages as of July 31. Invesco percentages as of Aug. 26.

Going with the equal-weight ETF doesn’t mean sacrificing returns

Over the past decade, the S&P 500 has outperformed the Invesco S&P 500 Equal Weight ETF, rising 233% compared to its 153%. However, since the ETF hit the market in April 2003, the roles have switched, and the ETF has outperformed.

RSP data by YCharts

Past results don’t guarantee future performance, but it’s worth noting that the ETF tends to outperform the market during periods when the broader market is rallying, the early stages of market recoveries, or periods when smaller companies and more value-based stocks are outperforming megacap tech stocks.

With the S&P 500 being as seemingly overvalued as it is — and what has happened historically when it has reached these levels — this seems like a good time to hedge against the standard S&P 500 and its reliance on the Magnificent Seven stocks.