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Ask a Fool: Do Small-Cap Stock Funds Beat Large-Cap Funds?

By Matthew Frankel, CFP® – Apr 20, 2018 at 12:00PM

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Or is this common theory wrong?

Q: I'm 30 and selecting my 401(k) investments. Should I put most of my money in a small-cap stock fund, since they tend to beat large-cap funds over time?

The idea that a given group of small-cap stocks will outperform a group of large-cap stocks over time certainly makes sense. After all, small-cap companies tend to have much more room to grow. In other words, it's typically far easier for a company with a $1 billion market cap to double in size than it is for, say, Microsoft.

However, while the common perception is that small caps tend to outperform large caps, the data doesn't entirely support that view. In fact, from 1979 through 2015, the broad small-cap Russell 2000 index produced annualized total returns of 11.4%, while the benchmark large-cap S&P 500 index produced an even better 11.7% annualized, and with significantly lower volatility.

There's also far more that can go wrong with smaller companies. For instance, it's more likely for the average $1 billion company to go bankrupt than the average large-cap company, and bad news tends to scare investors of smaller companies more than larger ones. This is why small-cap stocks tend to be more volatile than large caps, especially over shorter periods of time.

I'm not saying that small cap stock funds are a bad investment choice by any means. I'm simply saying that they aren't necessarily a superior long-term investment choice to large-cap funds, especially when considering the added volatility.

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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