Fundamental Indexing

A new school of investing claims that exchange-traded funds based on the Standard & Poor’s 500-stock index, such as the SPDR S&P 500 ETF (SPY), are flawed.

The problem, according to a recent column by John Spence, is that the S&P 500 can become top-heavy with pricey shares by using companies’ market value as a way to weight stocks.

The new school is offering fundmentally-indexed funds that weight stocks by factors such as high dividend yields and low share-price-to-earnings ratios. The backers claim that these funds are less risky and offer a better chance for long-term outperformance.

Examples of fundamentally indexed funds in Spence’s column include the PowerShares FTSE RAFI US 1000 Portfolio ETF (PRF) and the WisdomTree LargeCap Dividend Fund (DLN).

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