The common theme in investing is more risk, more reward. Fixed income investments, such as bonds and certificates of deposit (CDs), can provide guaranteed returns, but they are extremely low. Stocks can provide virtually unlimited return potential, but there is always the chance that you will 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 probably due to the resources that generally come with more size. But that generally reduces the possibility of exponential growth.
Small cap companies have a market capitalization between approximately $300 million and $2 billion. Due to their small size, they have the potential for hyper-growth, providing big returns to their investors along the way. However, with this possibility of hyper-growth comes increased risk because small-cap stocks are more prone to volatility and may not have as many resources as large-cap companies to weather bad economic storms.
Focus on small-cap index funds
Owning small-cap stocks is a good decision for any investor, but during bear marketsWhen volatility can be intense, it’s a good idea to avoid investing in individual companies and focus on small-cap index funds that track the US small-cap market as a whole. the Vanguard Russell 2000 ETF (NASDAQ: VTWO) it’s an example.
the Russell 2000 Index is largely considered the primary benchmark for small-cap stocks (similar to the S&P 500 for large-cap stocks). With an investment in the Vanguard Russell 2000 Index Fund, you’ll instantly invest in 2,003 small-cap stocks covering 11 major sectors.
There’s no guarantee that specific small-cap companies will come out of the bear market unscathed, but it’s a safe bet that a broad index like the Russell 2000 will find a way to bounce back and produce good long-term returns. Although small-cap stocks tend to take more hits during bear markets, they also tend to reap more rewards in early bull markets and when the economy is recovering.
Now is the time to go discount shopping
Small-cap stocks have high volatility and risk, so you never want the majority of your portfolio to be in them. However, you want some exposure to small cap stocks for growth potential. If it’s not too much of your portfolio, you can usually justify the risk. you probably won’t see Amazon-like returns if you’re invested in a broad, small-cap index fund like the Russell 2000, but the index has proven to be a good long-term investment, especially if you can get stocks at a “discount.”
From September 2008 to March 2009, during the great recession, the Russell 2000 fell more than 46%. From there, it increased more than 100% less than two years later. From its February 2020 high to its March 2020 low, it fell close to 40%. Since then, it’s up more than 79% since then, though down more than 20% year-to-date (as of July 21, 2022).
Of course, historical performance does not guarantee future performance in any way. 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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