The Vanguard Small-Cap Value Index Fund ETF tracks the CRSP U.S. Small Cap Value index. As a value-oriented index tracking fund, the ETF doesn't offer the highest share price growth potential, but it should outperform in bear markets. That's because valuations, especially of high-priced stocks, tend to compress in recessions.
Investors need to be clear about the trade-off they are making when they consider a value fund. This and other value-oriented investments tend to underperform when the markets are soaring, but can provide valuable ballast at times when markets are under pressure.
Currently, the fund offers a dividend of 2% and an attractive expense ratio of 0.07%.
How small-cap index funds work
Small-cap index funds work by passively tracking a small-cap stock market index, like the Russell 2000. The fund aims to hold the same stocks in similar proportions to mirror the index's performance, offering broad diversification in smaller, high-growth companies with lower costs than active funds, but with higher volatility.
In this way, small-cap index funds provide a simple way to gain exposure to potentially explosive growth from emerging businesses, balancing risk across hundreds of companies instead of picking individual stocks.
Benefits of small-cap index funds
- Portfolio diversification: Investing in a small-cap index fund exposes your portfolio to a wide range of small-cap stocks across different sectors. Diversified portfolios generally perform better than non-diversified holdings because owning the stocks of many different companies ensures that your portfolio's performance is not strongly correlated with the performance of any specific stock and is more resistant to bear markets.
- Risk reduction: Small-cap stocks can be risky since they tend to move cyclically with the broader economic cycle. They are also more volatile than large-cap stocks. Investing in an index fund eliminates some of the risk because the fund gives you a stake in dozens of companies.
- Bull market gains: Although large-cap companies are more likely to be profitable, have better access to capital, and can better withstand recessions, small-cap companies tend to outperform during bull markets, which occur when the stock market is on the rise.
- Attractive growth potential: The stocks of small-cap companies have historically outperformed those of large caps thanks to their greater growth potential.
Key factors to consider when choosing a small-cap index fund
Small-cap stocks are generally considered more volatile than larger companies and can be more vulnerable to market fluctuations and economic headwinds. Investors who tend to worry about market volatility might want to limit their exposure to small-caps.
The best remedy for volatility is time in the market. Small-cap stocks and the funds that hold them tend to be better suited as long-term investments, providing the time needed to ride out economic cycles.
When picking between individual funds, investors should be focused on cost-effectiveness. You can't control the direction of the market or the performance of individual stocks. But you can control the fees you pay on your investments. Look for the expense ratios listed on individual fund websites, and try to find low-cost options.
