Don't Ignore These Winners in 2010

You probably know that owning several different types of stocks can both protect you from dramatic losses during market declines and make you richer in the long run. But even if you have a portfolio that's reasonably well-diversified, you may well be completely ignoring an entire group of stocks -- including some that have brought investors big gains both recently and over the long haul.

Missing the middle
When you were a beginning investor, the first companies you probably looked at were the megacap blue-chip names that you had heard about all the time. For instance, if you were focusing on top news items like health-care reform, the stocks you would have followed most closely were companies like Merck (NYSE:MRK) and UnitedHealth (NYSE:UNH), which stand near the top of their respective industries.

After you felt comfortable investing in big companies, you may have started exploring small-cap stocks. Their youth and small size made them arguably riskier than blue chips, but they also carried the prospects of much larger profits. And once you added small-cap stocks to your portfolio, you may have felt you had a completely diversified set of stocks.

Yet along the way, you may have missed an important piece of the overall market puzzle. In order to have a truly diversified portfolio, you need to fill in the blank between small and large companies. In the spaces in between, you'll find mid-cap stocks -- and you might be surprised just how lucrative they can be.

Bridging the cap gap
There's no one definition of what a mid-cap stock is. Some put the range between $1 billion and $10 billion in market capitalization; others point to the S&P Midcap 400's average market cap of about $2.2 billion as a benchmark, although its components range from as big as $7 billion to as small as $230 million. According to Standard and Poor's, mid-caps make up about 7% of the overall U.S. stock market, and with hundreds of companies to choose from, you'll find a big selection of stocks in a variety of industries. Some of them are household names, while you've probably never heard of others -- at least not yet.

There are good reasons to look closely at mid-cap stocks. Unlike small-cap stocks, mid-caps have generally been around longer, and have had a chance to build a track record of strong financial performance. Their stocks have usually seen substantial price rises as well, given that many companies start as small caps, only rising to mid-cap status once they're successful.

Yet unlike most large-cap stocks, mid-caps still have a long way to go in terms of reaching their full potential. Of course, when you get in a bit late to the game, you won't see the same returns you would have realized from being among the first investors in stocks like priceline.com (NASDAQ:PCLN) or Joy Global (NASDAQ:JOYG). But in comparison to mature companies that clearly have their best growth behind them, mid-caps can still pack a punch with big gains. 

Where the money is
In fact, mid-cap stocks are getting a lot of attention lately, given how well they've done in the recent rally. Just take a look at how these mid-cap mutual funds have done lately:

Source: Morningstar. As of Dec. 10.

Overall, mid-caps are outpacing both their larger and smaller rivals. So far this year, the S&P Midcap 400 index is up more than 32%, compared to just 25% for the S&P 500 and 18% for the S&P Smallcap 600. More importantly, mid-caps' 10-year average return of 6.6% beats the small-cap Russell 2000's 3.8% over the same period -- and puts the loss that large-caps have suffered to shame.

If you don't have mid-cap exposure in your portfolio, then you're missing out on an important element of a diversified investing strategy. With a healthy combination of the best attributes of both smaller and larger stocks, mid-caps may truly be the just-right investment for you right now.

This year's winners can easily become next year's losers. Read about Anand Chokkavelu's look at the hottest stocks of 2009.