What are small-cap stocks?
Small-cap stocks are shares in companies that are, well, smaller in size. Of course, “small” in this context is a relative term. Small-cap companies generally have a market capitalization — what the company is worth on the open market — of between $300 million and $2 billion.
These companies aren’t necessarily tiny start-ups or new to the stock exchange. Many of them are as established, well-managed, and financially fit as their large-cap alternatives.
Advantages and disadvantages of small-cap stocks
Small-cap stocks tend to have much higher appreciation potential than large-cap plays like Walmart or 3M, for example, whose days of rapid growth are largely behind them.
Thanks to that upside, small-cap indices like the S&P 600 and Russell 2000 have historically outperformed the broader market over prolonged periods of time.
Investors also benefit from the lack of attention and analysis small-caps receive.
Many large hedge funds and mutual funds don’t even consider small-cap companies because they’re not big enough to move the needle. That lack of institutional demand often results in small-cap shares being undervalued.
Of course, there are also risks involved.
Small companies are exposed to a number of threats that large-cap companies are not.
They may not have the financial or managerial wherewithal to weather a major crisis. In times of need, they may not have access to new sources of capital or credit.
Small-cap stocks also involve a certain amount of inconvenience.
They’re not especially liquid, so selling them in a short period of time at a desirable price can be challenging. And because they aren’t heavily publicized, finding accurate, useful information about small-cap companies can be a challenge.
Why now is the time for small-cap stocks
Just as opportunistic investors stormed the market after it dipped during the height of the pandemic, the small-cap space is now providing a chance to buy low.
In July, the Russell 2000 fell 9% in just a few short weeks. And over the past three months, the small-cap index is essentially flat versus a return of 6% for the S&P 500.
In other words, small-cap stocks are nicely set up at the moment for a strong reversal.
But choosing where to invest on a company-by-company basis is highly risky, especially for beginners. Investing in a low-cost ETF that provides exposure to a wide number of small-cap stocks is a much simpler (and safer) way to approach the space.
Some of the most popular small-cap ETFs include:
iShares Core S&P Small-Cap ETF (IJR). Managed by fund giant Blackrock, this S&P SmallCap 600-tracking ETF has a whopping $69 billion in assets under management. The ETF is up about 22% year to date, but its performance over the past three months has been flat, making it a timely value proposition.
Vanguard Small-Cap Growth ETF (VBK). With $38 billion under management, this is one of Vanguard’s largest small-cap offerings. VBK has only returned 6.5% in 2021, suggesting it might have some room to run in the second half of the year.
Schwab U.S. Small-Cap ETF (SCHA). Charles Schwab’s $16.4 billion fund provides access to more than 1,700 small-cap stocks trading in the U.S. Over the past six months, SCHA has been flat.
Put your money to work
If you’re ready to explore the small-cap world a little more thoroughly, or just get into the market before the reversal comes, there are several convenient ways to do it.
Popular investing apps can get you the small-cap exposure you’re looking for, while also giving you the chance to pick up a free share in large-cap companies like Apple, JP Morgan, or Johnson & Johnson.
And if you’re an investor on a budget — most of us are — you can always start investing in a diversified portfolio using little more than the “spare change” left over from your everyday purchases.
No matter which method you choose, remember this: Small-cap stocks provide significant upside potential over the long term, and today looks like the perfect time to jump in.
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