Small-cap stocks refer to the shares of companies with a relatively small market capitalization, typically ranging from $300 million to $2 billion. These stocks often belong to newer, growth-oriented firms and tend to be more volatile than their large-cap counterparts. While small-cap stocks offer the potential for higher growth and returns, they also carry greater risk. Investors in small-cap stocks must be prepared for increased volatility, as these companies are more susceptible to market fluctuations and have a higher likelihood of going bankrupt compared to larger, more established firms. However, small-cap value index funds have been shown to outperform the S&P 500 in the long run, making them an attractive option for investors willing to accept the higher risk.
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What are the advantages of investing in small cap stocks
- Potential for higher growth: Small-cap companies tend to have more room for growth compared to larger, more established firms, offering investors the opportunity for higher returns.
- Less competition from institutional investors: Regulations restrict large institutional investors like mutual funds from heavily investing in small-cap stocks, leaving more opportunities for individual investors.
- Possibility of outperforming large-caps: Small-cap value index funds have historically outperformed the S&P 500 in the long run.
- Lower share prices: The share prices of small-cap stocks are often lower, making the initial investment more accessible for some investors.
- Variety of businesses: Small-cap companies can be found across different industries, not just in start-ups, providing diversification options.
- Less popular/covered: Small-cap companies tend to receive less attention from analysts and the media, meaning they may be undervalued and provide solid return potential for investors willing to do their own research.
In summary, the key advantages of small-cap stocks are their higher growth potential, less competition from institutional investors, possibility of outperforming large-caps, lower share prices, business variety, and potential for finding undervalued opportunities through less coverage.
what is the typical return on investment for small cap stocks
Small-cap stocks have historically provided higher returns compared to large-cap stocks, but with greater volatility. Specifically:
- From 1997 through 2012, the Russell 2000 index of small-cap stocks returned 8.6% on an annualized basis, compared to 4.8% for the S&P 500 index of large-cap stocks.
- From 2003 through 2013, small-cap funds yielded an average annual return of 9.12%, while large-cap funds yielded a return of 7.12%.
- Over the past 20 years, the S&P SmallCap 600 index, a benchmark for small-cap stocks, has returned an average of 8.3% annually, compared to 8% for mid-caps and 6.3% for large-caps.
So in summary, the typical long-term annualized return for small-cap stocks has been in the range of 8-9%, outperforming the 6-8% returns of large-cap stocks, though with higher volatility.
