Title: Taking a Chance with Small-Cap Stocks: The Risks and Rewards
If you've ever dreamt of investing in the next big thing, like *Amazon (AMZN* -0.04%), then small-cap stocks might be worth considering. Small companies, with market cap sizes ranging from about $300 million to $2 billion, can sometimes see exponential growth, potentially skyrocketing 100 times their initial value. But this excitement comes with some risks.
The Risks of Investing in Small-Cap Stocks
Investing in small-cap enterprises means you're accepting some volatility. While some investors may thrive on unpredictable fluctuations, others might not be as comfortable with wild swings in value. During times of market turmoil, as revealed by the *CBOE Volatility Index (VOLATILITYINDICES:^VIX*), larger-cap stocks often outperform their smaller counterparts, as shown in the graph below.
[Small-cap index vs S&P 500]
Another challenge is that small-cap stocks usually don't pay out dividends, as smaller companies often need every dollar to grow their business. Larger, more mature companies, however, tend to have reliable profit streams and a surplus of cash to spare.
Small-cap companies can struggle to turn a profit as well. Their recent ventures, with less certain long-term prospects, leave them more at risk of failure. And while small-cap stocks can deliver significant gains during a bull market, they often underperform during a bear market, as demonstrated during the early months of the COVID-19 pandemic.
[Graph of small-cap index vs S&P 500 during bear market and pandemic]
The Rewards of Investing in Small-Cap Stocks
Despite the inherent risks, small-cap stocks offer several advantages as well. Their potential for growth is higher than that of large-cap stocks, primarily because it's simpler for a $1 billion company to double its worth than it is for a $1 trillion company to double its. In addition, small-cap stocks often receive less attention from Wall Street, granting retail investors an opportunity to invest before institutional investors follow suit.
Smaller-sized companies are also more likely to uncover hidden gems among under-valued stocks, as broader investors focus on larger and more established entities. Furthermore, small-cap stocks have historically outperformed their larger counterparts during a bull market. Once a small-cap company has realized significant growth, it may progress to a mid-cap or even a large-cap status.
Fitting Small-Cap Stocks into Your Portfolio
Investors should focus on growing small-cap companies, with characteristics such as high revenue growth, youth, and participation in growing industries like cloud computing and e-commerce.
Small-cap index funds, such as the Vanguard Small Cap Index Fund, offer a diversified investment option for those seeking broad exposure to small-cap stocks. These passive funds can contain small-cap stocks and stocks of formerly small-cap enterprises that have grown to a significant market value.
Related Investing Topics
Looking for other investment options? Check out our guides on Investing in Mid-Cap Stocks and Investing in Large-Cap Stocks. By understanding these various investment opportunities, you can create a well-rounded portfolio that maximizes growth potential.
Final Thoughts
Investing in small-cap stocks carries its share of risks and rewards, but their higher growth potential compared to larger-cap stocks can be enticing. Decide if small-cap stocks are a worthwhile addition to your investment strategy based on your risk tolerance, portfolio size, and long-term investment goals. As with all investments, conduct thorough research and due diligence before making a financial commitment.
Given the text, here are two sentences that contain the words 'finance', 'money', and 'investing':
- If you have some extra money in your finance budget and are interested in investing, small-cap stocks might provide an interesting opportunity for potential returns.
- Successful investing in small-cap stocks requires a good understanding of the company's financials, its growth potential, and the risks involved, just like in any other investment strategy.
