I wouldn’t touch individual small cap stocks with a 10ft pole right now | Smart Change: Personal Finances
The common theme of investing is more risk, more reward. Fixed income investments, such as bonds and certificates of deposit (CDs), can offer guaranteed returns, but they are extremely low. Stocks can offer virtually unlimited return potential, but there is always a chance that you will lose money.
The same risk-reward tradeoff also applies to different types of stocks. The larger the company, the more stable it is likely to be due to the resources typically associated with larger size. But this generally reduces the chances of exponential growth.
Small cap companies have a market capitalization between approximately $300 million and $2 billion. Due to their small size, they have a chance for hypergrowth, delivering excellent returns to their investors along the way. However, with this chance for hypergrowth comes more risk, as small-cap stocks are more prone to volatility and may not have as many resources as large-cap companies to weather bad economic storms.
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Focus on small cap index funds
Owning small cap stocks is a good move for any investor, but during bear markets when volatility can be intense, it’s a good idea to avoid investing in individual companies and focus on funds. small cap indexes that track the US small cap market. in general. The Vanguard Russell 2000 ETF (NASDAQ: VTWO) is an example.
The Russell 2000 Index is widely regarded as the primary benchmark for small cap stocks (similar to the S&P500 for large cap stocks). With an investment in the Vanguard Russell 2000 index fund, you’ll instantly be invested in 2,003 small-cap stocks covering all 11 major sectors.
There’s no guarantee that some small-cap companies will emerge from 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 deliver good long-term returns. Even though small-cap stocks are generally hit harder during bear markets, they also tend to reap more rewards in early bull markets and when the economy recovers.
It’s time for discount shopping
Small cap stocks have high volatility and risk, so you never want most of your portfolio in them. However, you want some exposure to small cap stocks because of the growth potential. If that’s not too much for your wallet, you can usually justify the risk. You probably won’t see Amazon– similar returns if you’re invested in a large, small cap index fund like the Russell 2000, but the index has proven to be a good long-term investment, especially if you’re able to buy stocks at a “discount”.
From September 2008 to March 2009, during the Great Recession, the Russell 2000 fell over 46%. From there, it grew to over 100% less than two years later. From its February 2020 high to its March 2020 low, it has fallen almost 40%. It has since risen over 79% since then, although it is down over 20% since the start of the year (as of July 21, 2022).
Of course, historical performance is no guarantee of future performance. 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 Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Stefon Walters has no position in the stocks mentioned. The Motley Fool holds positions and recommends Amazon. The Motley Fool has a disclosure policy.