Market Cap Weighted Indexes Suffer From a Systematic Flaw

Market-cap weighted indexes, such as the Standard & Poor's 500, are not a "very smart way to invest," the author of The Big Secret for the Small Investor told CNBC Friday.

Market-cap weighted indexes "will systemically buy too much of the overpriced stock and too little of the bargain priced stocks," Joel Greenblatt explained.

"A few simple ways to fix that is you can equally weight the stocks. So, in other words, in the S&P 500 just buy an equal amount of each stock. You'll still make plenty of errors, but those errors will now be random and not systematic."

Another concept is value weighted index portfolios, which seek to avoid the losses due to inefficiencies of market-cap weighting while adding performance by buying more stocks when they are available at bargain prices.

"It sounds ridiculously simple, we just buy more of the cheaper stuff," Greenblatt concluded.

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