The Only Place for Great Growth

You know that stocks offer most people the best route to riches -- but do you know by how much?

Take a look at the following annual compound returns between 1925 and 2004, courtesy of Ibbotson Associates:

I usually cite this data to demonstrate why putting all your eggs in the bond basket is shortsighted -- but do you see anything else interesting?

Check out the difference between small-cap stocks and large-cap stocks; in that case, 2.3 percentage points is quite a gap. If your $50,000 nest egg grows by 10.4% annually for 20 years, it will become $362,000. If it grows at 12.7%, it will become $546,000 -- a difference of more than $180,000!

That's the kind of performance you want in your portfolio.

Charles Schwab speaks
Small caps gain a lot of their power from having so much room to grow.

Charles Schwab, founder of the eponymous brokerage firm, recently put it this way in Equities magazine: "You don't have to hit home runs every time, but there are reasons that equities outperform almost any other instrument." Those reasons?

You can take a company from one office to 300; you can take a company from 10 employees to 14,000. Equity investing is all about this wonderful, simple term called growth. You can't get that growth in real estate, you can't get it in bonds, and you can't get it in cash investments. You can only get it in equities.

Although Schwab was speaking of stocks in general, what he said goes double for small caps. ExxonMobil, the largest company trading on U.S. exchanges, may continue to grow, but it would have to tack on $380 billion to double in value. Compare that to Bare Escentuals, which would only have to add $360 million to double. Bare Escentuals has room to become a double-bagger, triple-bagger, or even 10-bagger from here. If Exxon tripled, it would be worth more than $1 trillion -- nearly 9% of the 2007 U.S. GDP. To put it mildly, that's not too likely.

Small is beautiful
Buying into good companies when they're small enough to grow can have a direct effect on your portfolio. Check out the average annual growth rate of these companies over the past two decades:

Data from Yahoo! Finance, from November 1988, 1998, and 2008.

It's true that the decade from 1988 to 1998 posted 16% average annual gains, compared with (3%) for the most recent 10-year period. But although each of these companies outperformed the S&P 500 in both decades, their outperformance when they were small dwarfs their outperformance after they beefed up.

The Foolish bottom line
If you want your portfolio to do its best, a few well-chosen small caps are just the thing. At Motley Fool Hidden Gems, we look for strong insider ownership, low debt, smart management, and generous free cash flow.

If you'd like to see what small caps we're recommending today, consider taking a free, 30-day trial of Hidden Gems. You'll see all of our current and past recommendations, as well as our best bets for new money now. Their picks are beating the market by more than percentage points -- and now you know just what a difference that can make. Just click here to get started, with no obligation to subscribe.

Longtime Fool contributor Selena Maranjian owns shares of Wal-Mart and Amgen. Wal-Mart is a Motley Fool Inside Value recommendation. Bare Escentuals is a Hidden Gems and a Rule Breakers pick. The Motley Fool is Fools writing for Fools.