Small-cap stocks outperformed large-cap stocks in 2020 and that trend is expected to continue in 2021, many analysts say, citing Biden administration policies that will help Main Street more than Wall Street, among other reasons. The Russell 2000, which is the major index tracking small-cap performance, was up 20% in 2020 while the S&P 500 rose 18.4%. The difference so far this year is more pronounced: Through the market close Friday, the Russell 2000 was up about 11.5% year to date while the S&P 500 was up roughly 1.5%.
While market trends shift over time, small caps should be part of a diversified investment portfolio to capture gains when large caps are weaker. Finding the right individual small-cap stocks can be a challenge in part because of the more volatile nature of smaller companies, so exchange-traded funds (ETFs) can be a great solution. Two of the largest small-cap stocks funds are the iShares Russell 2000 Growth ETF (IWO -1.34%) and the Schwab U.S. Small-Cap ETF (SCHA -1.35%). Which one is the better buy?
iShares Russell 2000 Growth ETF
The iShares Russell 2000 Growth ETF is the fourth-largest small-cap ETF, holding about $12.9 billion in assets. It tracks the Russell 2000 Growth Index, which includes about 1,100 stocks with higher price-to-value ratios and higher levels of forecast growth. It has a median price-to-earnings ratio of 36.5 and a median price-to-book ratio of 6.2, with a standard deviation, which is a measure of volatility, of 48.5%.
The largest holdings in the ETF include Plug Power, Caesars, Penn National Gaming, Sunrun, Deckers Outdoor, Redfin, Churchill Downs, Ultragenyx Pharmaceutical, Mirati Therapeutics, and Arrowhead Pharmaceuticals.
Launched in 2000, this ETF has been a stellar performer. In 2020, it rose 34.5% and it has 5-year and 10-year annualized returns of 16.4% and 13.6%, respectively. All that and an expense ratio of 0.24%, which is lower than the category average of 0.32%.
Schwab U.S. Small-Cap ETF
The Schwab U.S. Small-Cap ETF, launched in 2009, is the third-largest in the small-cap universe with roughly $15.3 billion in assets. It tracks the Dow Jones U.S. Small-Cap Total Stock Market Index. That's a broader index than the Russell 2000 Growth, containing 1,750 stocks.
For reference, the Dow Jones U.S. Large-Cap Total Stock Market Index tracks the 750 largest U.S. companies by market cap. Those with valuations from No. 751 through No. 2,500 fall within the Small-Cap Total index.
The Schwab U.S. Small-Cap ETF has a median P/E ratio of 21.8, a median P/B ratio of 2.3, and a standard deviation of 14.3%. Its top 10 holdings are Plug Power, Caesars, Penn National Gaming, Novocure, Cloudflare, Cree, 10X Genomics, Five Below, Repligen, and Darling Ingredients.
The ETF returned 19.3% in 2020. Over the last five years it has posted an annualized return of 12.9% and over the past 10 years has returned 11.6% on an annualized basis. Also, this ETF has a rock-bottom expense ratio of 0.04% -- well below the 0.32% category average. That means that investors pay just 4 cents in fees for every $100 they have invested.
Which is the better buy?
If you're looking at returns, it's hard not to lean toward the iShares ETF. It has delivered better results over the 1-year, 5-year and 10-year periods than the Schwab fund. The Schwab fund is doing better thus far in 2021, though -- it was up about 10.7% through Friday, compared to the iShares fund, which was up by about 8% year to date.
The Schwab ETF obviously has a much lower expense ratio at 0.04%. Not that the iShares ETF's fees are high at 0.28%, but the Schwab ETF will cost the investor next to nothing in fees, and that can add up to a significant difference over time, especially when large sums are involved. It also has a much lower standard deviation, meaning the underlying stocks have lower volatility.
Your preference between these two ETFs might depend on your risk tolerance or your expectations for the market over the next few years. If you're anticipating another 10-year bull market, you'll have a different take on this decision than someone who foresees more volatility over the next decade than we saw in the last one.
It may also depend on your time horizon. If you're picking in one of these ETFs for a retirement-focused portfolio, then the iShares ETF will be the better choice because of its track record of long-term returns. If you're investing with a nearer-term goal in mind for the money, you may feel more comfortable with the more diversified, less risky Schwab ETF.