Let’s take an example to understand different types of weighting schemes that can be used to construct portfolios. Suppose you are very impressed with government’s announcement regarding recapitalization (injecting more money) of public sector banks. You believe that this will lead to stocks of public sector banks performing well in the future and want to invest in the same. You have read smalltalk’s article on benefits of diversification and know that you need to invest in multiple banks, rather than just one banking stock, to avoid company specific risk. Thus, you decide to invest in the following 5 public sector banks

  1. State Banks of India (SBI),
  2. Punjab National Bank (PNB),
  3. Bank of Baroda (BOB),
  4. Bank of India (BOI) and
  5. Allahabad Bank (ALBK).

In total, you want to invest a sum of INR 50,000 in these stocks. Now the question is how much should go into each stock? This is determined by weighting scheme. Generally, there are 3 different types of weighting schemes:

  1. Equi-Weighted
  2. Market-cap Weighted
  3. Custom Weighted

Let’s look at the first two in detail