We all have the same goal when it comes to trading.
Like most investors, one of our top goals has been to enjoy a financially secure retirement at whatever age you choose. That being the case, it stands to reason that your retirement “nest egg” should ideally generate above-market returns, often with below-market risk.
Believe it or not, the “best of the best” can be found with small cap stocks, historically
Between 1926 and 2006, small cap stocks outperformed large cap stocks by an average 2.3%. While that may not sound great, consider this. Had you invested $10,000 for 30 years, you would have earned 10.4% a year (the long-term return of the S&P 500 over that period), it would have grown to $194,586. However, had you invested that same $10,000 in small cap growth, you would have seen a compound return of 12.7% and a return of $361,175.
Small Cap Stocks have Other Advantages
Lack of Coverage: Typically, small cap stocks fly well under the radar because many institutional investors cannot invest in them without driving up the price. In addition, many mutual funds are not allowed to invest more than 5% of their money in a single stock.
Smaller Stocks can Grow Faster: The biggest companies produce revenue of $100 billion and more. It takes a long time for companies like that to double sales of that size. In contrast, you’ll often find small companies that are growing sales at a much faster clip.
Safer in Times of Global Despair: Driving further interest into small cap stocks is the fact most are insulated from geopolitical issues, such as trade war fears. Remember, small caps have much less exposure to international headaches than companies in the S&P 500.
However, small cap stocks can be riskier.
Smaller companies are often startups with an unproven business model, and perhaps limited access to capital. This makes their prospects less certain than those of blue-chip companies that everyone has confidence in and knows well.
Other Key Data to Know about Small Cap Stocks
Size: In the 2007 edition of the Ibbotson yearbook, the largest company in the smallest decile had a market cap of just $314 million. Compare that to $1.2 billion, the mean market cap of all companies in small-cap funds covered by Morningstar. There are also companies worth far less than $1 billion. To invest in these, it’s often best to look to mutual funds or ETFs, where diversification helps to soften the overall risk.
Top Small Cap ETFs include: iShares S&P Small Cap 600 Growth ETF (IJT), the Vanguard Small Cap ETF (VB), iShares Russell 2000 ETF (IWM), and the iShares Core S&P Small Cap ETF (IJR). All offer great diversification using some of the most heavily traded small cap stocks. Small-cap ETFs tend to have more growth potential than their large-cap counterparts.
Inside ownership: Companies run by people with plenty of skin in the game have extra incentive to see the stock flourish.