Investing doesn't have to be complicated. A simple portfolio of exchange-traded funds (ETFs) may be all you need to produce excellent returns over the long run.

Many people will allocate their entire stock portfolio to an S&P 500 or total stock market index fund. And while that can be a great foundation for any portfolio, history suggests investors will do well by tilting their holdings toward small-cap value stocks. That means putting more money in smaller companies trading at cheap valuations than you'd get by investing in a total stock market index fund.

The easiest way to achieve that goal is through an ETF, and one of the best in the space is the Vanguard S&P Small-Cap 600 Value ETF (VIOV 1.24%). And right now may be an ideal opportunity to buy shares. Here are five reasons why.

1. Small-cap value stocks historically outperform

We can look to history to see why it's smart to add a small-cap value ETF to your portfolio. From 1926 through May 2023, small-cap value stocks outperformed the broader market. They returned 14.1% annually during that period compared to 10% from the overall market.

That hasn't been the case in the recent past, though. Small-cap value stocks have been trounced by large-cap growth stocks over the past decade. The S&P 500 Growth index, for example, has returned 246% over the past decade. The Russell 2000 Value index has returned just 65% in the same period.

But that may make it an even better opportunity for investors to buy right now.

2. Small-cap stocks are currently undervalued

Because small-cap value has underperformed so much over the past decade, the valuation gap between small-cap and large-cap stocks has rarely ever been this wide. The S&P 600 small-cap index has a forward price-to-earnings (P/E) ratio of 14.6 versus a 20.4 forward PE for the large-cap S&P 500.

The last time the valuation gap was this wide was in the early 2000s. That period was followed by strong outperformance by small-cap value stocks relative to the S&P 500. The market could be setting up for another period of outperformance for small-cap value after years of languishing.

3. The Vanguard S&P 600 is more concentrated in small caps

Not every small-cap value fund is created the same. The Vanguard S&P Small-Cap 600 Value ETF has a greater concentration of small-cap stocks than its sister fund, the Vanguard Small-Cap Value ETF (VBR 1.34%). The former is 100% invested in small-cap stocks, according to Morningstar Research. The latter, however, holds about 30% of its assets in mid-cap stocks.

The discrepancy stems from the index each fund tracks. There's a hard limit on the market cap for inclusion in the S&P 600, which currently stands at $6.7 billion. The Vanguard Small-Cap Value ETF tracks the CRSP US Small Cap Value index, which captures the bottom 15% of stocks ranked by market capitalization. That results in a much wider range of equities in the index.

So, if you want more concentrated exposure to small caps, focusing on an ETF that tracks an index like the S&P 600 will produce better results.

4. Every company in the fund is profitable

What makes the S&P 600 different from other small-cap indexes is the profitability requirement for inclusion. Every company in the index must be profitable in its most recent quarter and over the trailing four quarters.

Profitable businesses historically produce better returns long-term than unprofitable companies. That may stem from better downside protection during market declines, which can have a larger impact on smaller stocks than larger equities.

As such, the S&P 600 index is a great candidate for finding the best small-cap value stock investments.

5. The economic outlook is good

One of the biggest reasons for small-cap underperformance recently has been the uncertain economic outlook. Rising inflation has led the Fed to raise interest rates and prompted concerns of a recession.

Rising interest rates hit small companies harder than large enterprises. Small companies often use floating-rate debt as opposed to long-term bonds, which means higher interest rates have an outsize impact on their earnings. Moreover, higher interest rates also push investors to demand higher risk premiums from risky small-cap stocks, further pushing current prices down.

Small-cap equities also typically fare worse during recessions. And as recession fears grew, investors may have ditched small-cap stocks.

However, the outlook is improving. The Fed has likely stopped raising interest rates and expects to start cutting them this year. Meanwhile, many believe we've avoided a recession. Both factors should help small-cap stocks' performance going forward.