Small cap can be big
We know that a typical long-term stock portfolio returns more, on average, than a typical bond portfolio. But what kind of stocks consistently outperform the broad stock market as a whole? Hint: Think smaller.
Since 1926, a dollar invested in small cap stocks has grown to $18,365 – a hefty annualized return of 11.9 percent. Over the same 87-year period, large cap stocks grew a dollar to $3,533 or 9.8 percent annualized return.
In more recent history, since 1983, small cap stocks turned a one dollar bill into $2,400 or 11.2 percent annualized return. Again, this beats the performance of large cap stocks. The S&P 500 experienced a 10.8 percent annual return over the same period. In spite of catastrophes such as the 2000 tech bubble, 9/11, and the great recession, the long-term rates remain fairly constant with small caps outperforming large caps.
ETFs allow you to index in many ways: by geography, capitalization, style, sector, etc. State Street, Vanguard, and iShares, to name a few, offer many ways to index small cap stocks. For example, Vanguard’s VB, allows you to own approximately 1,400 small cap US securities through a single investment. How does it stack up? Since inception in 2004, VB is up 232 percent compared to 181 percent for SPY, the investible version of the S&P 500 large cap index. That’s 8.8 percent annually for small caps and 6.2 percent for large caps.
Indexing is Darwinian
How many of those original small cap securities from 1926 are still in existence today? Probably very few. In the famous Dow Jones 30 Stock Index, General Electric is the sole surviving original member. One reason we like indexing is that it allows losers to drop out, winners to get picked up, and most importantly the index to continue on as a representation of the asset class despite changes in individual securities.
Flavor your portfolio
Small cap stocks don’t beat big caps every year, but over the long-term they tend to outperform their bigger siblings by about 2 percent a year. It’s no surprise then, that they are more volatile. To earn that better long-term expected return, investors must be willing to accept more risk.
Depending on our clients’ goals and required long-term return, we often include a small stake in a small cap focused ETF to provide access to their higher expected returns. Because small can be big.
This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.
Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.
Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.
An investment cannot be made directly in an index. Any securities are mentioned for illustrative purposes only and may or may not be held in client accounts.
Investment in small –cap stocks may involve more volatility and risk, whether made individually or through an indexed fund.