Price-weighted and equal-weighted indexes
A price-weighted index adds one share of each constituent and divides by a divisor, so high-priced shares dominate and splits shift the weights. An equal-weighted index holds the same amount of money in each constituent, so its return is the average of their returns since the last rebalancing.
Watch the lesson 15 min
The video follows this page: the same examples, then the checkpoint questions.
Before this: Index value, price return and total return
On the exam
- Describe the choices and the implications of the different weighting methods used in index construction and management, and calculate, interpret, and explain the value and the returns of an index
Describe these weighting choices and calculate index values and returns. Expect a price-weighted return from a price table (the average of returns is a trap), a new divisor after a split, an equal-weighted return, and which index a split affects more.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
How does price weighting work?
Lesson 2 showed that every index divides an aggregate value by a divisor. This lesson covers the two simplest weightings; lesson 4 covers market value and fundamentals.
In price weighting each constituent’s weight is its share price divided by the sum of all the prices. The aggregate is the sum of one share of each constituent, and the index value is that sum divided by a divisor . Holding the index is like owning one share of each constituent.
This lesson and the next use one three-stock table. Prices are in USD, shares outstanding in millions and dividends per share are paid during the period.
| Stock | Start price | End price | Shares (m) | Dividend |
|---|---|---|---|---|
| X | 80 | 88 | 50 | 2.00 |
| Y | 25 | 24 | 200 | 0.50 |
| Z | 45 | 54 | 40 | 0.00 |
What happens when a share splits?
A stock split divides a share’s price, so the sum of prices falls even though nothing economic has changed. To stop the index from dropping, the provider changes the divisor so that the index value is the same just after the split as just before.
A price-weighted index has a divisor of 0.15 and the prices of its constituents add up to 150.00. A split cuts the sum of prices to 120.00. The new divisor that leaves the index unchanged is closest to:
120.00 × 0.15 ÷ 150.00 = 0.12
New divisor0.12
- 120×0.15÷150=
- 120ENTER0.15×150÷
ENTER enter (on the HP, puts the number on the stack)
A divisor is also changed when a constituent is replaced.
Price weighting is simple to calculate and understand, but it does not reflect market values, and very high share prices skew it. It is rare today, used mainly by the Dow Jones Industrial Average (30 shares) and the Nikkei 225.
How does equal weighting work?
In equal weighting every constituent gets the same weight, 1 ÷ N, at the start of the period. The index return is then the simple average of the constituents’ returns, measured from the last rebalancing date.
How is an equal-weighted index built?
Use it
To build an equal-weighted index, hold a number of shares of each constituent so that every holding has the same value at the start. The index value is the value of the holdings divided by a divisor.
Only since the last rebalancing
Memorize
The equal-weighted return equals the average of the constituents’ returns only when the weights are equal at the start of the period, that is, measured from the last rebalancing date. After one period here the weights have drifted to 33.7%, 29.4% and 36.8%.
Lesson 5 shows how the provider restores equal weights.
Equal weighting stops the largest companies from dominating and gives smaller companies relatively more weight. Its drawbacks: weights drift and must be rebalanced often (often quarterly), which is costly, and small companies are less liquid and harder to replicate. That is why few managers build portfolios this way.
- Price-weighted Memorize aggregate = sum of one share of each
- Weight price ÷ sum of prices
- Return change in the sum of prices
- Upkeep new divisor after splits and swaps
-
- Equal-weighted Memorize aggregate = equal holdings n_i × P_i
- Weight 1 ÷ N at each rebalancing
- Return average of returns since the last rebalancing
- Upkeep frequent rebalancing
-
How do the two methods compare on the same table?
They give different returns because the weighting rule is different. Price weighting follows the change in the sum of prices (10.67%). Equal weighting averages the returns (8.67%). A third method, market-cap weighting, gives 5.19% on the same table, and the next lesson shows how.
Try this 0 of 3
- Select Stock Z and split it 3-for-1
- Switch to Equal and compare the return with Price
- Under Price, edit the start prices so Stock Y gets the biggest weight
Same table, every rule (price return)
- Price10.67%
- Equal8.67%
- Market cap5.19%
Price-weighted: Stock X 53.3%, Stock Y 16.7%, Stock Z 30.0% at the start. Price return 10.67%, total return 12.33%. Same table under the other rules: Equal 8.67%, Market cap 5.19%. Same three shares, three different index returns. The weighting rule is the whole story.
Show working
Index value = sum of prices ÷ divisor; weight = price ÷ sum of prices.
Start: (80.00 + 25.00 + 45.00) ÷ 0.15 = 1,000.00
End: (88.00 + 24.00 + 54.00) ÷ 0.15 = 1,106.67
Price return = 166.00 ÷ 150.00 − 1 = 10.67%
Total return = (166.00 + 2.50 dividends) ÷ 150.00 − 1 = 12.33%
Weights: X 53.3%, Y 16.7%, Z 30.0%
- 88+24+54=÷(80+25+45)−1=0.1067, so 10.67%
- 88ENTER24+54+80ENTER25+45+÷1−0.1067, so 10.67%
ENTER enter (on the HP, puts the number on the stack)
Go deeper Why price-weighted indexes survive, and what splits do over decades
Price weighting is the oldest method. It needs only prices and a divisor, so it could be calculated by hand a century ago. Some of the most quoted indexes still use it. Because companies tend to split their shares as prices rise, the shares that have done best get the lowest prices per share, and so lose weight. Over decades a price-weighted index drifts away from the winners. That is a quirk of the method, not a view about the companies.
Go deeper The hidden tilts of equal weighting
Giving the same weight to a very small company and a giant means equal weighting holds far more small companies than the market does. It also sells winners and buys losers each time it rebalances, which is a mild contrarian pattern. Both tilts mean its returns can differ from a market-cap index even when the target market is the same.
Memorize this
MemorizePrice weighting versus equal weighting
| Price-weighted | Equal-weighted | |
|---|---|---|
| Weight of i | ||
| Index value | (base 100 or 1,000) | |
| Return | change in ÷ start | average of returns since the last rebalancing |
| Bias | high-priced shares; splits shift weights | small companies overweighted |
| Upkeep | new divisor after a split | frequent rebalancing |
Memory hook Price: one share of each, so the dearest share leads. Equal: the same money in each, so a small firm counts like a giant.
Know it cold After a split, new divisor = new sum of prices ÷ old index value, so the index does not move. A split matters to a price-weighted index, not to an equal-weighted one.
- Price-weighted Memorize aggregate = sum of one share of each
- Weight price ÷ sum of prices
- Return change in the sum of prices
- Upkeep new divisor after splits and swaps
-
- Equal-weighted Memorize aggregate = equal holdings n_i × P_i
- Weight 1 ÷ N at each rebalancing
- Return average of returns since the last rebalancing
- Upkeep frequent rebalancing
-
Quick example
Prices 30, 60 and 90 with a divisor of 0.18 (set for a base of 1,000). 180 ÷ 0.18 = 1,000.
- 30+60+90=÷0.18= 1000
- 30ENTER60+90+0.18÷ 1000
ENTER enter (on the HP, puts the number on the stack)
Quick example
Prices go from 30, 60, 90 to 33, 57, 99. The sum rises from 180 to 189, so the return is 9 ÷ 180 = 5.00%. The 90 share carries 90 ÷ 180 = 50% of the weight.
- 189÷180−1= 0.05
- 189ENTER180÷1− 0.05
ENTER enter (on the HP, puts the number on the stack)
Quick example
Prices 40, 60 and 100 with a divisor of 2.00 give an index of 100. The 100 share splits 2-for-1, so the sum falls to 150. New divisor = 150 ÷ 100 = 1.50.
- 40+60+50=÷100= 1.5
- 40ENTER60+50+100÷ 1.5
ENTER enter (on the HP, puts the number on the stack)
Quick example
Hold 90 X at 80, 288 Y at 25 and 160 Z at 45 (7,200 in each). 21,600 ÷ 21.6 = 1,000.
- (90×80)+(288×25)+(160×45)=÷21.6= 1000
- 90ENTER80×288ENTER25×+160ENTER45×+21.6÷ 1000
ENTER enter (on the HP, puts the number on the stack)
Quick example
Four shares return 8%, −2%, 5% and 1%. (8 − 2 + 5 + 1) ÷ 4 = 3.00%.
- 8+2+|-+5+1=÷4= 3
+|- change sign
- 8ENTER2CHS+5+1+4÷ 3
ENTER enter (on the HP, puts the number on the stack) · CHS change sign
How it is asked
-
Divisor after a split
Prices 18, 42, 150; index 100.00 with a divisor of 2.10. The 150 share splits 5-for-1. New divisor?
New sum 18 + 42 + 30 = 90. 90 ÷ 100 = 0.90. Traps: 2.10 (unchanged), 0.42 (2.10 ÷ 5).
-
Equal-weighted return
Four shares return 8%, −3%, 7%, 2%. Equal-weighted return?
(8 − 3 + 7 + 2) ÷ 4 = 3.50%. Traps: 14% (no division), 5.00% (sign of −3% dropped).
-
Who dominates a price-weighted index?
The largest weight in a price-weighted index belongs to the…
Highest-priced share, not the largest company.
-
Same table, three answers
Which option is price-weighted, which equal-weighted?
Price: change in the SUM of prices. Equal: AVERAGE of returns. Options are built from the other methods. Another common distractor is the average of P₀ ÷ P₁ − 1, the prices inverted.
-
Which index does a split hit?
One constituent splits 2-for-1. Which index sees its weights change?
The price-weighted one. In an equal-weighted index the holding is worth the same before and after.
Exam traps
- Leaving the divisor unchanged after a split. The index would fall for no economic reason.
- Averaging returns for a price-weighted index, or averaging P₀ ÷ P₁ − 1 (prices inverted).
- Believing the largest company dominates a price-weighted index. The highest-priced share does.
- Treating the equal-weighted return as the plain average in a period that did not start from a rebalancing.
- Setting the divisor equal to the number of constituents. It is whatever gives the chosen base.
Checkpoint
4 exam-style questions. About 90 seconds each.
1A price-weighted index of three shares priced 24, 56 and 160 stands at 100.00 with a divisor of 2.40. The share priced 160 splits 4-for-1. The new divisor is closest to:
2Four shares in an equal-weighted index return 12%, −3%, 6% and 1% over a month. The index's return is closest to:
3Three shares are priced 20, 50 and 130 and rise to 22, 47 and 143. The return on a price-weighted index of the three is closest to:
4One share is in both a price-weighted index and an equal-weighted index. It splits 2-for-1, and nothing else changes. The split most likely changes the share's weight in:
Key takeaways
- Price-weighted value = sum of prices ÷ divisor; reset the divisor after splits so the index does not jump.
- Price-weighted return = change in the sum of prices ÷ the starting sum.
- Equal-weighted return = average of returns since the last rebalancing; it needs frequent rebalancing.
- Price weighting favors expensive shares; equal weighting favors small companies.
Quick example
Prices 30, 60 and 90 with a divisor of 0.18 (set for a base of 1,000). 180 ÷ 0.18 = 1,000.
- 30+60+90=÷0.18= 1000
- 30ENTER60+90+0.18÷ 1000
ENTER enter (on the HP, puts the number on the stack)
Quick example
Prices go from 30, 60, 90 to 33, 57, 99. The sum rises from 180 to 189, so the return is 9 ÷ 180 = 5.00%. The 90 share carries 90 ÷ 180 = 50% of the weight.
- 189÷180−1= 0.05
- 189ENTER180÷1− 0.05
ENTER enter (on the HP, puts the number on the stack)
Quick example
Prices 40, 60 and 100 with a divisor of 2.00 give an index of 100. The 100 share splits 2-for-1, so the sum falls to 150. New divisor = 150 ÷ 100 = 1.50.
- 40+60+50=÷100= 1.5
- 40ENTER60+50+100÷ 1.5
ENTER enter (on the HP, puts the number on the stack)
Quick example
Hold 90 X at 80, 288 Y at 25 and 160 Z at 45 (7,200 in each). 21,600 ÷ 21.6 = 1,000.
- (90×80)+(288×25)+(160×45)=÷21.6= 1000
- 90ENTER80×288ENTER25×+160ENTER45×+21.6÷ 1000
ENTER enter (on the HP, puts the number on the stack)
Quick example
Four shares return 8%, −2%, 5% and 1%. (8 − 2 + 5 + 1) ÷ 4 = 3.00%.
- 8+2+|-+5+1=÷4= 3
+|- change sign
- 8ENTER2CHS+5+1+4÷ 3
ENTER enter (on the HP, puts the number on the stack) · CHS change sign
Questions about this lesson?
Where this comes back
- Market-cap, float-adjusted and fundamental weighting Benchmarking Returns
- Rebalancing, reconstitution and what indexes are used for Benchmarking Returns
Questions candidates ask
How do you adjust the divisor of a price-weighted index after a stock split?
Add up the prices with the post-split price, then divide that sum by the index value from before the split. The new divisor keeps the index where it was. The divisor was set at the start so the index began at a round base such as 100 or 1,000.
Why is an equal-weighted index rebalanced often?
Price moves change each share's weight, so the provider must trade back to equal weights. That adds turnover and cost.
What is the main weakness of price weighting?
Weights depend on share price levels, which are arbitrary and change with splits. A split in one share changes the weight of every constituent.
Is an equal-weighted index return always the average return of its constituents?
Only from the last rebalancing date. Once prices move, the weights are no longer equal, so the next period's index return is a weighted average until the provider rebalances back to equal weights.
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