For investors who specialize in small-cap investing, trying to find the top stocks of tomorrow can easily turn into a full-time occupation. But if you want to include small-cap stocks in your portfolio but don't want to turn it into a second profession, it's still possible to get the benefits of investing in small companies -- thanks to some simple tools.
ETFs and small-cap investing
Yesterday, I looked at how investors can use exchange-traded funds to create a core portfolio of large-cap stocks. But even though large caps play an important role in the overall strategy that most investors use, they won't single-handedly give you the optimal mix of performance and risk that you want.
Specifically, investing in small caps can bring a number of benefits, including the following:
- Better overall returns. Historically, small-cap stocks have outperformed their larger counterparts over long periods of time.
- Diversification. Small caps don't always rise and fall in lockstep with the rest of the market. For instance, small caps have done a lot better than large caps during and immediately after recessions. At other times, they zig when larger stocks zag, helping investors find gains even when big companies face a tougher market envrionment.
- A chance at the big time. Whereas large-cap stocks have typically put their fastest growth phase behind them, some small caps still have explosive growth ahead of them.
Because of these advantages, finding the best small caps is both important and valuable. Utilizing the ETF universe to discover the best way to get your small-cap exposure can have a big impact on your investing success.
Small caps by the thousand
Perhaps the most popular index of small-cap stocks is the Russell 2000. Composed of stocks with market caps ranging from just a few hundred million dollars up to $4.5 billion, the Russell 2000 includes stocks such as Human Genome Sciences
There are alternative small-cap indexes that have ETFs tracking them, such as the S&P Smallcap 600 and the MSCI Small Cap 1750. These indexes have slightly different focuses; an ETF that tracks the S&P version counts Green Mountain Coffee Roasters
Finding the right focus
As we saw yesterday, it's easy to find a place for narrowly focused large-cap ETFs in your portfolio, in part because most investors allocate a fairly large percentage of their overall assets to large caps. In contrast, because many investors confine their small-cap investing to a relatively small fraction of their total investments, sticking with a broad-market small-cap ETF often serves as the best choice.
However, that doesn't mean there aren't good niche small-cap ETFs to choose from. Both iShares and Vanguard offer ETFs that only include the growth or value sides of each small-cap index.
In addition, if you're interested in really small stocks, you can find a fund that only includes the tiniest publicly traded companies. The Russell Microcap index includes the smallest 1,000 stocks from the Russell 2000 as well as 1,000 even smaller stocks and has a median market cap of just $131 million. You can buy in through the iShares Russell Microcap ETF (IWC).
No matter which ETF you decide to use to fill out the small-cap portion of your investing portfolio, you still get the flexibility of buying and selling shares at any time during the trading day. All it takes to get started is to open a brokerage account and pick the ETFs that fit best with your investing strategy.
You don't have to be a full-time investor to have access to top investments. Thanks to exchange-traded funds, you can include small-caps in your investment portfolio in a simple and easy way.
Stay tuned all this week to Dan's "Simple Ways to Win" series. Tomorrow, Dan takes a look at investing in international stocks.
Fool contributor Dan Caplinger is a simple man with a simple plan. He doesn't own shares of the companies mentioned in this article. Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. Atwood Oceanics is a Motley Fool Stock Advisor selection. Tupperware Brands is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. It doesn't get simpler than The Fool's disclosure policy.