One of my investing commandments is Thou shalt diversify. For the stock portion of your investment portfolio this means buying large company stocks and small company stocks from all over the world.
Read on to learn more about the punch that small company stocks can give your portfolio.
Michelle Morris, CFP®, EA
BRIO Financial Planning
I recently reviewed a prospects investment portfolio.
She had a lot of different mutual funds in several different accounts. A mutual fund is a convenient way to buy a basket of many stocks or bonds. Because she had a lot of funds in a lot of accounts she thought she was well diversified, but she was not.
Nearly all of her holdings were US large cap mutual funds. Large cap means large company. Cap is short for Capitalization which is the dollar value of a companys existing stock shares. Examples of large cap companies are Apple, Microsoft, Google, Johnson & Johnson companies weve all heard of and may or may not love.
The definition of small varies, but generally it is a company with value of ≈$300 million to $2 billion. So we are not talking about Bill and Bobs Backyard Widgets.
Examples of small company stocks include regional banks such as Bancorp South and the Bank of Hawaii .
Companies like Coherent, Inc. the worlds leading supplier of laser solutions in Santa Clara, CA.
Or Knight Transportation a truckload motor shipping carrier in Phoenix, Arizona.
I recommend that nearly all investors own some small cap or small company shares (in the form of a mutual fund). Why do I recommend this? Well, as Willie Sutton said when asked why he robbed banks because that is where the money is.
Over time small cap stocks have out-performed large cap stocks
as seen in this graph: (Source: Ibbotson)
If you invested one dollar in the S&P 500 in 1926 (the 500 largest US stocks), it would have grown to $6,021 by the end of 2016. Pretty good!
But if you invested one dollar in small cap stocks in 1926, it would have grown to $33,212 (!)
Small caps are a bumpier ride (meaning they are more volatile).
And they dont outperform large caps every year. Which is why I dont recommend you go all in on smalls. In fact, I dont recommend you go all in on anything! Bringing us again to one of my investing commandments Thou shalt diversify.