The Russell 2000 is the market's most commonly used benchmark for small caps. While it has its flaws, it's consistently demonstrated that it can do very well in the right environment. And it provides investors one of the most comprehensive ways to invest in this category.
The Vanguard Russell 2000 ETF (VTWO 1.64%) is one of the best and cheapest ways to target this index. Its expense ratio of 0.06% is one of the lowest in this space. And its willingness to hold every stock in the index, rather than just most, to achieve a close approximation ensures that this ETF remains very tightly linked to the Russell 2000.
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Why the Vanguard Russell 2000 ETF works in the current market
The index includes roughly 2,000 stocks ranked by market cap after the Russell 1000 large-cap index is fully populated. In broad terms, it includes U.S. stocks with market caps ranked between 1,001 and 3,000.
Outside of some basic liquidity screens, that's the criteria. It includes everything within that market cap range -- good and bad, profitable and unprofitable.
In bull markets, that can be a good thing. Those unprofitable stocks can often outperform as investors feel more willing to take a chance on more speculative companies with higher upside. Over long-term investing cycles, that exposure is preferable because it gives you plenty of time to ride out the highs and lows.
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Key Data Points
Russell 2000 vs. S&P 600
When investing in small caps, it's important to understand the two most popular indexes for investing in them. The S&P 600, which funds such as the iShares Core Small Cap ETF are linked to, actually looks much different than the Russell 2000.
The S&P 600 essentially comprises the stocks ranked by market cap that fall outside the S&P 500 and S&P MidCap 400 indexes. But it also has a quality screen. To qualify for the index, stocks must have positive earnings over the past quarter and, in aggregate, over the past 12 months.
That creates two big differences. The S&P 600 is tilted toward larger companies, as well as higher-quality companies. That could be a consideration if you want a less risky option that mitigates some downside risk.
Overall, I believe that the Vanguard Russell 2000 ETF presents the best option for long-term investors. Its target market cap range provides truer exposure to the small-cap market. It's much more all-inclusive than alternate indexes. And over long time frames, it's generally better to include both high-quality and lower-quality companies to capture the benefits of multiple market cycles.
