When I heard that Dow Jones had selected Kraft Foods to replace AIG in the Dow Jones Industrial Average, I couldn't believe it. Kraft (NYSE: KFT)? I mean, I love mac 'n' cheese as much as the next guy, but ... Kraft? What about the 14 companies I highlighted as likely candidates for the Dow? What about my two favorites—Amgen and Wells Fargo? I really thought Amgen would get the nod. Biotech represents an increasingly important part of the American economy, and picking Amgen would show that Dow Jones was embracing the future of American commerce and not just the well-established past. And Wells Fargo? What a statement that would have been about the continued importance of the Financial sector in today's economy! Wells Fargo is a well-run bank, and probably deserves a place in the Dow 30. It would have been nice to look past the headlines and recognize that. Still, now ...

There are three key approaches to indexing competing for investor attention:  Market-Cap Weighting, Equal Weighting, and Fundamental Weighting.  Let’s explore how they differ.

Market-Cap weighting is the traditional and predominant method of index weighting today.  The S&P 500 index (proxy SPY or IVV) is an example.  Companies are weighted in the proportion that their free-float market-cap has to the total free-float market-cap of all the companies in the index.  Giant companies dominate the index and its performance. This tends to be momentum biased.

Criticism - this method systematically overweights overvalued stocks and underweights undervalued stocks.

Equal weighting is less widely used, with fewer investment fund opportunities.  The S&P 500 Equal Weight index (proxy RSP) is an example.  Each company is represented in equal amounts in the index. Each company contributes equally to index performance.  This alternative method removes the systematic overweighting and

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