1 ETF Outperforming the S&P 500 in 2025 That Could Continue to Do So For the Foreseeable Future

The stock market is off to a very volatile start in 2025.

After climbing to an all-time high in February, the stock market started capitulating amid fears of President Trump's forthcoming tariff policies. Expectations of an all-out trade war accelerated the sell-off after Trump announced higher-than-anticipated tariffs at the start of April. Investors are now concerned about international reactions to the administration's position, the impact on inflation, and ultimately, whether a trade war could push the economy into a recession (if we're not already in one).

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As a result, the S&P 500 (SNPINDEX: ^GSPC) declined nearly 20% at one point before recovering some of those losses after Trump announced a 90-day pause on higher reciprocal tariffs (except China). News on Wednesday suggested Trump might be easing some of his tariff plans for China, giving a boost to the market (at least for the moment). Year to date, the benchmark index is down roughly 7.3% as of this writing.

A simple ETF has proven more resilient, beating the benchmark index's 2025 performance by roughly three percentage points. What's more, investors can reasonably expect the index fund to continue outperforming, not just through 2025, but for the foreseeable future.

Image source: Getty Images.

The ETF that makes more sense than the S&P 500 right now

An index fund tracking a broad-based index like the S&P 500 is typically a safe recommendation. It guarantees you'll get your fair share of the stock market returns. In fact, an S&P 500 index fund typically outperforms the vast majority of actively managed mutual funds. However, a standard S&P 500 index fund comes with some significant drawbacks that are exacerbated right now.

The drawbacks stem from the fact that the S&P 500 is a market-cap-weighted index. That means the biggest companies in the world have much more influence over the index's value than smaller companies.

That's become an issue recently because the biggest companies currently sport relatively high valuations. Their forward PE ratios typically fall in the high-20 to 30 range. The S&P 500 10-year average is 18.3. That valuation put added pressure on the index recently because the impact of tariffs could significantly shrink future earnings for those big companies with significant international operations and supply chains.

It's worth pointing out that the S&P 500 has become extremely concentrated over the last few years. Even after a strong sell-off of the biggest companies in the index, the top 10 constituents of the S&P 500 account for more than one-third of the index's value. Combined with their relatively high valuations, that led Goldman Sachs analysts to slap a long-term total return outlook on the S&P 500 of just 3% per year over the next decade last October.

The good news for investors is that there's a simple index fund that can correct for those issues: the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP). The S&P 500 equal weight index, as the name implies, weights each company's stock in the S&P 500 equally. So, the biggest company in the world gets as much room in the portfolio as companies 499 and 500.

Here's why that's a good investment right now and for the long run.

Finding value in an expensive market

As mentioned, the biggest companies in the S&P 500 tend to have valuations well above the historical average of the index. But if you look at the forward price-to-earnings (P/E) ratio of the equal weight index, it looks far more appealing. The Invesco ETF trades for a forward P/E of less than 16 as of this writing. Granted, the price-to-earnings ratio isn't the most reliable right now, but it still sits well below the cap-weighted index's forward P/E of 19.4.

Warren Buffett has also been a fan of looking at smaller S&P 500 companies for value. In fact, he's sold tens of billions of dollars' worth of the largest stocks in the S&P 500 over the last two years in favor of putting money to work in smaller constituents. Investors shouldn't ignore the Oracle of Omaha's portfolio moves. They say something very clear about the current state of the stock market.

However, the investment thesis for the equal-weight index goes beyond valuation. The long-term returns of the index should outpace the S&P 500. That's because smaller companies generally outperform larger companies over the long run. That's due to the law of large numbers. It's typically harder for a $3 trillion stock to increase 10% than it is for a $30 billion stock. One takes $300 billion of additional capital, and the other takes just $3 billion.

The long-term returns of the equal-weight index prove this. Over the last 30 years, the equal weight index has produced a cumulative total return of 2,000% versus the S&P 500's 1,720% return. While the equal-weight index hasn't outperformed over the last decade, it looks poised to experience a reversion to the mean. That makes it a great option for ETF investors looking to take advantage of lower prices amid the current stock market sell-off.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.