Understanding the weight of stocks in S&P 500 indexes

Question

I'm reading about S&P 500 stock list here, https://www.slickcharts.com/sp500

It looks like each stock has a different weight, e.g MSFT has 7% but V has 1%, why is that? What's the problem of being equal here?

Answer 1

https://www.investopedia.com/articles/investing/090414/sp-500-index-you-need-know.asp says:

The S&P 500 is calculated by adding each company's float-adjusted market capitalization.

This seems to make sense, since companies of the same size may choose to have very different share prices. One billion-dollar company might have a hundred million shares worth $10, another might have a million shares worth $1000. $1 in movement on the former is a 10% gain ($100 million market cap increase), while on the latter it’s only 0.1% ($1 million market cap increase). The S&P index is trying to reflect the total size of the included companies.

Answer 2

What's the problem of being equal here?

Suppose you created your own index of 5 equally-weighted stocks (A, B, C, D, and E) and wanted to create a fund that tracks that index. Suppose also for simplicity that they all have a price of $1 per share. You buy 100 shares of each stock for a total fund value of $500.

Tomorrow, B, C, and D are unchanged, but A rockets to $2 and E drops to $0.50. Your index is still equally-weighted, but is the fund? You now have twice as much invested in A , and half as much invested in E as the other 3 stocks, so your fund is no longer equally weighted. You must sell off some of A and buy more E to stay on track with the index.

That is why market cap weighting is the predominant weighting scheme for indexes. The weighting automatically adjusts with share price, and only needs to be re-balanced when there is a merger or spinoff (a split does not affect market cap), or when companies are added/removed from the index.

It's also why there are not many funds that track the Dow Jones Industrial Index. It's a very easy index to calculate for humans (and was created long before computers) but very hard to replicate, since it must be re-balanced constantly.