There are plenty of avenues for investors to gain exposure to a wide variety of stocks, but if you want to benefit from small-cap companies, which are typically worth between $300 million to $2 billion, then one of your best options is the Russell 2000 index, which is a collection of -- you guessed it -- about 2,000 small publicly traded domestic companies.
Buying the Vanguard Russell 2000 Index ETF (VTWO -1.11%) can be a great way to diversify your investment across many different companies, but lately, the index hasn't performed as well as the S&P 500. The Vanguard Russell 2000 Index ETF is up about 25% over the past three years, while the S&P 500 has gained 66%.
So, is it worth buying this Russell 2000 ETF? I think it's best not to put your money into this popular ETF right now for two reasons.
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The fund isn't tapping into one of the largest tech trends
One of the biggest downsides for the Vanguard Russell 2000 Index ETF right now is that it has limited exposure to artificial intelligence. Even if you don't think of yourself as a tech investor, the lack of AI companies in the index is notable because much of the recent gains (and potential future gains) are being driven by AI.
For example, the S&P 500 has benefited from big AI players like Nvidia, whose share price has skyrocketed more than 800% over the past three years, while the Vanguard Russell 2000 Index ETF has lost out on those gains because it doesn't have many large AI tech companies.
What's more, some of the small-cap AI companies that are in the index, including BigBear.ai, are far smaller players in artificial intelligence and, in my opinion, a speculative investment. While small-cap stocks can sometimes outperform larger ones, this hasn't always been the case with AI. With artificial intelligence estimated to become a nearly $16 trillion industry over the next five years, it's not exactly something you want to miss out on as an investor.
There's already a lot of volatility in the market
Let me say first that share price volatility is normal, and stock price swings can't be avoided, no matter where you put your money. However, small-cap stocks tend to be more volatile than the broader market and are usually a riskier place to put your money.
There's nothing wrong with that extra risk most of the time, but right now, the market has already experienced some very significant swings. For example, both the S&P 500 and the Vanguard Russell 2000 Index ETF were rising at the beginning of the year as some investors were optimistic about President Trump's business-friendly administration. But those gains were wiped out when Trump announced a slew of global tariffs.
Both the S&P 500 and the Russell 2000 rebounded from the initial tariff shock, but the S&P 500 is up more than 2% year to date while the Russell 2000 is still down about 5%.
While many economists have recently backed away from some of their most severe recession predictions, J.P. Morgan still puts the chances at 40% (down from 60% earlier this year) for one to occur this year. There's no telling whether it will happen or not, but the bank's prediction factors in the negative impact of tariffs as a potential catalyst.
Small-cap stocks tend to fall harder and faster when a downturn comes along. So, if tough economic times are ahead, then it follows that the Vanguard's Russell 2000 Index ETF could see a more significant drop, at least initially, than the broader market if a recession occurs.
Verdict: Now might be a good time to look elsewhere
I don't think the Vanguard Russell 2000 Index ETF is a bad place to put your money. Some investors may benefit from having more exposure to small-cap companies than they do now. Still, I think the fact that the ETF is missing out on the AI boom is a pretty big downside.
AI could end up being like the internet in terms of transforming the technology industry and how many people work, so having limited exposure to that just doesn't make sense for most investors. Instead, you might want to consider other Vanguard ETFs, some of which lean heavily into tech or track the S&P 500, as a good way to both diversify your investments and still tap into this fast-growing trend.
