Do small-cap stocks outperform large-cap stocks?
Small-cap stocks have historically outperformed their larger counterparts, but investment into this asset class should be approached with caution and suitable risk tolerance. They tend to offer higher returns in exchange for higher investment risk.
Small-cap stocks and large-cap stocks both come with their own pros and cons. While small-cap stocks can generate higher returns, they also have a higher risk profile. Conversely, large-cap stocks witness smaller growth but are more stable. Investors should consider investing in both for a balanced portfolio.
In an analysis of foreign and U.S. investments from December 1998 through June 2023, researchers at index provider MSCI found that small-cap stocks outperformed large firms over 15-year periods about 9 in 10 times.
Individual small-cap stocks offer higher growth potential, and small-cap value index funds outperform the S&P 500 in the long run. Small caps also experience higher volatility, and individual small companies are more likely to go bankrupt than large firms.
Investors pay close attention to the performance of smaller stocks because it offers signals about the health of the U.S. economy. Smaller companies typically outperform coming out of a recession. They rallied briefly in late 2020 after Covid-19 vaccines boosted hopes about an economic recovery.
Given that advisors are fond of saying that small cap stocks are much riskier than the stock of larger companies, it usually surprises investors to find out that, over long periods, small cap funds outperform their large cap counterparts. When you think about it though, it does make sense.
Small-cap stocks have a long-term performance advantage over large-cap stocks, and this is often referred to as the small-cap effect. Small-cap stocks are said to be economically sensitive and therefore rally in recoveries and lag heading into recessions.
Analysts forecast that 2024 earnings for small-cap companies will grow faster than large-cap earnings in most regions.
History shows that U.S. small-cap companies tend to outperform their larger counterparts when inflation and interest rates rise.
If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds. Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.
Should I hold small-cap stocks?
Small-cap stocks may be risky, but they offer the kind of life-changing growth that you won't typically find in large caps. If you've ever wished you could invest in the next Amazon (AMZN 0.31%), then small-cap stocks are probably a good choice for you.
- Indian Energy Exchange Ltd.
- Central Depository Services (India) Ltd.
- Aptus Value Housing Finance India Limited.
- Five-Star Business Finance Ltd.
- ICICI Securities Ltd.
- Easy Trip Planners Ltd.
- Eris Lifesciences Ltd.
- CE Info Systems Ltd.
A key reason for this is that small caps have struggled in the high interest rate environment more than large companies. Small caps tend to be more focused domestically with earnings growth often closely tied to how the U.S. economy is performing or sentiment about how the economy will perform.
The small cap funds offered an average return of around 17.48% in a five year period. Small cap schemes are benchmarked against Nifty Smallcap 100 - TRI, Nifty Smallcap 250 - TRI, and S&P BSE 250 Small Cap - TRI.
Russell 2000 companies' earnings are forecast to increase about 30% next year after falling 11.5% in 2023, LSEG data showed. "Small caps will snap back quickly and the recovery will be strongest in the early part," said Amisha Chohan, head of small cap strategy at Quilter Cheviot.
Long-Term Investors: Small-cap investments can be volatile in the short run, making them suitable for investors with a time horizon of seven years or more. Over the long duration, small-cap funds have the potential to generate significant returns.
VTI is a total U.S. market fund and holds more than 3,500 stocks. VTI is better diversified and benefits from small and mid-cap stocks that grow into large caps. VOO is less diversified, tracking the performance of the S&P 500 Index. VOO excludes small and mid-cap stocks.
Small caps refer to companies with a market capitalization ranging from $300 million to $2 billion. The stocks of small caps are prone to wide market fluctuations; hence, these are highly risky investments.
Size accounts for much of the performance difference. The median market cap of a company in the Russell 2000 was $1.04 billion as of February 2022 versus $31.3 billion for an S&P 500 member. Large cap stocks have been on a tear since the 2008-09 financial crisis, giving the S&P 500 a decided edge.
Mid-caps are slightly riskier than large-cap stocks and less risky than small-cap stocks. Small-cap stocks are riskier than the other two. Despite the risk, these stocks have great growth potential. Large-cap funds are usually less volatile unless there is some news.
How much should I invest in a large mid small-cap?
Aggressive investors: An aggressive investor can consider about 50-60 percent allocation to largecaps, 15-25 percent to midcaps and the remaining 15-25 percent to smallcaps.
| Stock | Expected Change in Stock Price* |
|---|---|
| Tesla Inc. (TSLA) | 61% |
| Mastercard Inc. (MA) | 14.2% |
| Salesforce Inc. (CRM) | 7.2% |
| Advanced Micro Devices Inc. (AMD) | 11.3% |
Equity investments require long-term horizons of preferably 3-5 years. But small-cap equity may require an even longer horizon of 5-7 years to account for periods of high volatility. A longer horizon gives you a much better chance of earning the higher returns you're taking the higher risks for.
If small-company stocks make up a small part of your portfolio, you're not alone. The consistent outperformance of larger companies over the past few years has left many investors under-allocated to littler ones, argues one investment manager. He believes now is the time for small companies to shine.
2024 may see a resurgence of small-cap stocks, challenging the recent dominance of large-cap stocks. Small caps are undervalued and well-positioned to capitalize on market trends, experts say.
