I’m not going to touch small cap single stocks with a 10-foot pole now | Smart Change: Personal Finance
The common theme in investing is more risk, more reward. Fixed income investments, such as bonds and certificates of deposit (CD), can provide guaranteed returns, but they are very low. Stocks can offer almost unlimited return potential, but there’s always the possibility that you could lose money.
The same risk-reward trade-off applies to different types of stocks as well. The larger the company, the more stable it is likely to be due to the resources that generally come in a larger size. But this usually reduces the chance of exponential growth.
The market capitalization of small businesses is between $300 million and $2 billion. Due to their small size, they have an opportunity for excessive growth, providing great returns for their investors along the way. However, with this opportunity for excessive growth comes more risk because small-cap stocks are more vulnerable to volatility and may not have as many resources as large companies to weather bad economic storms.
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Focus on index funds with small caps
Owning small stocks is a good decision for any investor, but during bear markets, when volatility is high, it’s a good idea to avoid investing in individual companies and focus on small index funds that track the small business market in the United States as a whole. The Vanguard Russell 2000 ETF (NASDAQ: VTWO) It is one example.
The Russell 2000 Index is largely the benchmark for small stocks (similar to Standard & Poor’s 500 for large-cap stocks). By investing in the Vanguard Russell 2000 Index Fund, you will immediately invest in 2,003 small stocks covering all 11 major sectors.
There’s no guarantee that certain small-volume companies will survive a bear market without getting hurt, but it’s a safe bet that a broad index like the Russell 2000 will find a way to bounce back and generate good returns in the long run. Although small-cap stocks usually take more hits during bear markets, they also tend to reap more gains in early bull markets and when the economy recovers.
It’s time to shop at discounted prices
Small-cap stocks have high volatility and risk, so you never want the bulk of your portfolio to be in it. However, you’ll want some exposure to small-cap stocks because of the growth potential. If there is not much in your portfolio, you can generally justify the risk. You probably won’t see AmazonLike the returns if you invest in a large scale small cap index fund like the Russell 2000, but the index has proven to be a good long-term investment, especially if you are able to get shares at a “discounted” price.
From September 2008 to March 2009, during the Great Recession, the Russell 2000 Index fell more than 46%. From there, it increased by 100% less than two years later. From the February 2020 high to the March 2020 low, it has fallen nearly 40%. It has since increased 79% since then, even while it has fallen more than 20% since then (as of July 21, 2022).
Of course, historical performance does not guarantee future performance by any means. However, if you focus on a small cap index like the Russell 2000, you can be more confident that it will weather the storm and provide long-term returns.
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John Mackie, CEO of Whole Foods Market, an Amazon company, is a member of The Motley Fool’s Board of Directors. Stefon Walters has no position in any of the stocks mentioned. Motley Fool has and recommends positions at Amazon. Motley Fool has a disclosure policy.