Small-Cap Stocks: The Hidden Gems of the Market
When it comes to tracking the performance of the stock market, most investors turn to the S&P 500, a benchmark that represents the largest companies in the US. However, there’s another important index that often flies under the radar: the Russell 2000, which focuses on small-cap companies.
What’s the Difference Between the S&P 500 and Russell 2000?
The S&P 500 comprises 500 large-cap companies, accounting for around 80% of the US equities market by value. The median market capitalization of these companies is a whopping $37 billion. On the other hand, the Russell 2000 includes nearly 2,000 small-cap companies, making up about 5% of the US equities market by value. The median market capitalization of these companies is around $1 billion.
Why Small-Cap Stocks May Outperform Large-Caps
According to Tom Lee, head of research at Fundstrat Global Advisors, small-cap stocks may outperform large-cap stocks by a significant margin in the near future. He cites two key reasons for this prediction: interest rate cuts and historically cheap valuations. With the Federal Reserve recently cutting interest rates, small-cap companies, which typically have more floating-rate debt, are likely to benefit more than large-cap companies. Additionally, small-cap stocks are currently undervalued compared to large-cap stocks, making them an attractive option for investors.
Backing Up the Prediction
Lee is not alone in his assessment. JPMorgan Chase strategist Michael Cembalest also believes that small-cap stocks are at their cheapest levels in the 21st century, with potential market and political catalysts in their favor. Goldman Sachs strategists Hania Schmidt and Jen Nusser have also highlighted the benefits of small-cap stocks in a recent blog post.
How to Invest in Small-Cap Stocks
One way to tap into the potential of small-cap stocks is through the Vanguard Russell 2000 ETF (NASDAQ: VTWO). This ETF tracks the performance of roughly 2,000 small-cap companies, including value and growth stocks from all 11 market sectors. The fund has a modest expense ratio of 0.1%, making it an affordable option for investors.
Important Considerations
While small-cap stocks may offer significant growth potential, it’s essential to keep in mind that they tend to be more volatile than large-cap stocks. Additionally, the Russell 2000 has historically underperformed the S&P 500 over the long term, largely due to its lower exposure to the technology sector.
A Balanced Approach
Ultimately, the most sensible approach may be to own both an S&P 500 index fund and a Russell 2000 index fund, prioritizing the former over the latter. By diversifying your portfolio, you can benefit from the growth potential of small-cap stocks while also mitigating risk.
Leave a Reply