By Jason Zweig

In theory, there's no difference between theory and practice. In practice, the difference is huge.

Many investing theories look great on paper, where taxes, fees and other frictions don't exist. Carried over into the real world, where friction is everywhere, theories often fade or fail in practice.

After my recent column on the S&P 500's heavy concentration in a handful of giant technology stocks, several readers emailed to ask whether an equally weighted index fund would be a better alternative as a core holding.

The short answer: In theory, yes. In practice, no.

To see why, let's run through some basics first.

An index, such as the S&P 500 or the Dow Jones Industrial Average, is theory. An index fund is practice.

No one can invest directly in an index. It's only a measure of how investments perform; it doesn't own anything.

An index fund, such as Vanguard 500 Index or State Street SPDR S&P 500, owns the investments in the index it tracks. The fund, unlike the underlying index, has to pay management fees and other expenses. It also incurs brokerage costs whenever it trades. Those frictions open a gap between theory and practice.

Let's look at the S&P 500 Equal Weight Index. It includes the same companies as the conventional S&P 500 -- with a twist.

The plain old S&P 500 represents those companies in proportion to their market capitalization. Giants such as Nvidia, Apple and Alphabet amount to 5% or more apiece.

The equal-weight index, by contrast, includes all the same companies -- but with approximately 1/500th, or about 0.2%, in each at the beginning of every calendar quarter.

The result is two very different baskets of the same stocks. Nvidia alone, despite its selloff this week, makes up almost 8% of the regular S&P 500, but only 0.2% of the equal-weight index. Technology stocks are 33% of the conventional S&P 500. They're just 13% of the equal-weight version, where industrial stocks are the biggest sector.

As a result, the performance of the equal-weight index is more dependent on smaller stocks. On average, its dividend is moderately higher and its valuation somewhat lower than the ordinary S&P 500.

Of course, part of investing successfully is to let your winners run. The equal-weight index flips that idea on its head. So when the biggest stocks generate huge returns, as technology giants were doing until recently, it lags behind.

When smaller, cheaper stocks earn higher returns than larger, faster-growing ones, as has tended to happen in the long run, the equal-weight index will outperform the capitalization-weighted index.

Sure enough, from April 2003 through this week, the S&P 500 Equal Weight Index returned an annualized 11.65% average return, edging past the 11.34% annualized gain of the S&P 500 itself.

Remember, though, indexes are theory. What about in practice?

Since its launch in April 2003, the Invesco S&P 500 Equal Weight exchange-traded fund, which tracks the index of the same name, has returned 11.20% annualized, according to FactSet. That's 0.45 percentage point less than its benchmark. The Vanguard fund tracking the plain-vanilla S&P 500, meanwhile, gained 11.31% annualized, or just 3/100ths of a point behind its index.

In other words, the equal-weight index beat the conventional index, but the equal-weight index fund didn't. In theory, you would have come out ahead in the alternative index fund, but in practice you would have finished behind.

That's partly because the Invesco fund's expenses are a little higher than Vanguard's, and partly because it has to trade more often. To keep its holdings approximately equal in size, the Invesco fund rebalances quarterly -- selling enough of any stock that has gone up, and buying enough of whatever's gone down, to get their weights back to roughly 0.2% each.

The portfolio turnover rate at the flagship Vanguard S&P 500 index fund, which doesn't have to rebalance extensively, runs only about 2% annually. At the Invesco equal-weight fund, it's averaged almost 22% over the past five fiscal years.

Joe Saluzzi, co-founder of Themis Trading, an institutional brokerage firm, points out that the largest, most active stocks are generally the cheapest to trade. A strategy that uses periodic rebalancing to keep holdings roughly equal means "you have to trade a lot more of those bottom names," he says. "That costs more, and that's a fact."

Invesco's global head of ETFs and index investments, Brian Hartigan, says, "The costs baked in reflect the value of consistently rebalancing the portfolio to the equal--weight index."

This isn't an isolated instance.

The late William O'Neil, founder of Investor's Business Daily (now owned by News Corp, which also publishes The Wall Street Journal), developed a stock-picking technique he called "CAN SLIM."

It often produced outstanding hypothetical gains. But his two mutual funds struggled to generate decent returns.

Value Line, the investment-research service, demonstrated for decades that its top-ranked stocks consistently beat the market. Yet funds based on Value Line's stock-picking system -- most recently, the First Trust Value Line 100 ETF, which was merged out of existence in 2020 -- generally haven't excelled.

There's a broader message here. The financial world is full of people and firms claiming that they have the secret, the magic key, the holy grail, that will enable you to beat the market. In theory, they're often right: It isn't that hard to outperform on paper.

In practice, though, you can't avoid the frictions of trading costs and taxes and inflation. Before you make any significant move in the market, always estimate what your net-net-net returns would be after paying those tolls.

Chances are, the theory won't stand up after it collides with real-world costs.

Write to Jason Zweig at intelligentinvestor@wsj.com

(END) Dow Jones Newswires

February 27, 2026 09:00 ET (14:00 GMT)

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