What is a potential disadvantage of an equal-weighted index?

An equal-weighted index gives every asset in the index the same weight, regardless of its market capitalization. This approach means that, unlike market-capitalization-weighted indexes, which give larger companies a greater influence, all companies have an equal impact on the index's performance.

One potential disadvantage of this structure is the higher transaction costs associated with the need for frequent rebalancing. As the prices of the underlying stocks fluctuate, the weights of the stocks in an equal-weighted index can drift significantly from their intended allocations. To maintain equal weighting, the index requires regular buying or selling of securities to bring them back to the designated equal weight. This frequent trading can accumulate substantial transaction costs, particularly in terms of commissions and bid-ask spreads, and can also lead to tax implications for investors who might have to realize gains during this rebalancing process.

The other aspects related to lower transaction costs, market cap concentration, and undiversified exposure do not apply in the same way. Lower transaction costs would not typically be associated with an equal-weighted index, as rebalancing entails costs. Increased market cap concentration is not a feature of equal-weighted indices since they deliberately avoid weighting by market cap. Finally, an equal-weighted index, in