Many stocks added to the S&P 500 are later removed. Index investors are forced to buy these "flip-flop" stocks *after* they have already appreciated significantly (avg. +75%), only to then participate fully in their subsequent decline (avg. -70%), locking in a substantial loss.
While equal-weighting avoids concentration risk, it's not a perfect solution. When applied to an index like the S&P 500, it still only includes companies that have already grown large enough to qualify, inheriting a bias towards higher-multiple stocks and excluding deep value opportunities.
Contrary to popular belief, the underlying business fundamentals (sales, profits) of value and growth indexes have grown at nearly the same rate this century. The vast performance gap is not due to better business results but rather investors' willingness to pay increasingly higher multiples for growth stocks.
So-called passive indexes have a small but impactful "active side" in their turnover. This component behaves like a flawed momentum strategy, forcing the index to systematically buy stocks after they've surged and sell them after they've plummeted, creating a performance drag.
A fundamental index (RAFI) naturally creates a value tilt by reweighting companies to their economic footprint. Therefore, its performance should be measured against cap-weighted value indexes, not the total market. Against this proper benchmark, it has added over 2% per year in live performance.