Small-cap stocks appeal to some investors because of their potential for strong growth. Still, not everyone can stomach their potentially higher volatility. Are they right for you, and if they are, how can you best add them to your portfolio?
First, some background. Small-cap stocks typically include companies with market capitalizations of $250 million to $2 billion, while mid-cap stocks range from $2 billion to $10 billion, and large-cap stocks have market capitalizations of greater than $10 billion. To review, the market capitalization of a company is its stock price times the number of shares it has outstanding.
Smaller-cap stocks typically have greater growth potential than larger-cap stocks. This is because smaller companies are generally more nimble than larger companies, so decisions about new products and services and adjustments when problems arise can be made and implemented quickly. This flexibility often helps smaller companies perform well.
But that is not always the case. According to conventional wisdom, small-cap stocks can perform better than larger-cap stocks (a) when markets have been down and are improving and (b) when interest rates are rising. At other times in the market cycle, larger-cap stocks may perform better. For example, when markets are declining, investors may prefer the security of well-known names and shun small-cap stocks in favor of large-cap stocks.
You probably know, however, that it is wise to avoid trying to time the market. Instead, we recommend choosing an appropriate asset allocation for your risk tolerance and financial goals and sticking with it over time. You may want to ensure your distribution includes some allocation to small-cap stocks, perhaps through a small-cap mutual fund, so you have adequate diversification among a number of small-cap companies.
We can help you decide if small-cap stocks are right for your financial goals and, if so, in what allocation. Please reach out if you have any questions or would like to consider adding these investments to your portfolio.