Looking back on historical performance, there is no question which major stock index performed best in the 15-year period from the beginning of 1999 to the end of 2013.

Although past performance is no indication of future results, the near-dominance of one particular index over the course of various economic and market conditions is a reasonable indication that the future may not look too different from the past.

I don't want to leave you in suspense (you might otherwise scroll down to get a quick answer, anyway) so I'll go ahead and tell you that the top-performing major market index of the past 15 years was the S&P Midcap 400.

Take a look at this simple spreadsheet I put together (the leading performance for each time period is boldfaced):

Notice that in the five-year, 10-year, and 15-year periods, the S&P Midcap 400 outperformed all other major stock market indexes. This is significant on many levels:

  • The five-year period captures nearly 100% of the current bull market, beginning March 9, 2009. Conventional wisdom would expect more aggressive stocks, such as small caps (think the Russell 2000) or pure growth (think the NASDAQ), to outperform.
  • More importantly, the 10-year period captures full economic and market cycles, which include the economic recovery and peak from 2003 to 2007, the Great Recession in 2008, the recovery beginning in 2009, and the current bull market. This suggests consistency in outperformance across various economic and market conditions.
  • The 15-year period includes all of the above, as well as the peak of the tech boom of 1999 and the subsequent bust of 2000 and 2001.

Why mid-cap stocks outperform small caps and large caps
Consider the recent history of Green Mountain Coffee Roasters (GMCR.DL). It went public as a small-cap stock in 1993. It took more than 15 years to reach mid-cap status of $2 billion in market capitalization in 2009. Yet it took only five more years to graduate to large-cap status in 2013, having doubled in price in the past year alone.

Best known for its popular Keurig machines, Green Mountain Coffee Roasters grew by making big licensing deals with the likes of Starbucks (SBUX 0.46%). More recently, Coca-Cola (KO 1.33%) bought a 10% stake in Green Mountain Coffee Roasters to get in on the K-cup craze.

Not every mid-cap stock boasts a growth story like Green Mountain Coffee Roasters, but these companies share similar trajectories. Mid-sized companies can be considered small companies that have achieved some success, growth, and maturation. In regard to performance, mid-sized companies hit the risk/reward sweet spot where absolute returns are still high, while market risk is lower than that of smaller companies.

Mid caps are still in the growth phase of the business cycle; their earnings and market share are rapidly growing. Meanwhile, large caps like Coca-Cola are fully matured, and often their best means of growing is -- you guessed it -- buying up mid caps!

Which mid-cap funds to use in a portfolio
So how might an investor wisely use mid-cap stock funds for their own advantage? I believe index funds and ETFs are the best way to capture mid-cap performance and to keep investing costs low. In fact, I haven't recommended actively managed mid-cap funds to clients in nearly 10 years. You see, actively managed mid-cap funds often drift into a large-cap style, especially after a few years of strong performance. This is because as a fund's assets under management grow, it can force the active fund-manager to buy stocks of larger market capitalization -- although this can be prevented if the manager closes the fund to new investors.

Meanwhile, with index funds or ETFs, you know what you're getting, and you can be confident the fund won't change its style in the future, because a passively managed fund only seeks to match the holdings and performance of an index, rather than attempting to beat it. You also get the long-term advantage of low expense ratios.

Two funds with good index-tracking records include the Vanguard Mid-Cap Index Fund (VIMSX 0.76%) and the Vanguard Mid-Cap ETF (VO 0.13%).

Mid-cap funds can be a wise addition to your portfolio, but be cautioned that higher returns may be accompanied by higher volatility, especially compared to a large-cap index such as the S&P 500.