Companies with small capitalizations are typically faulted with more risk and volatility, higher price-to-earnings ratios, and lower dividend yields than their bigger brothers on Wall Street. Investors may hear about how small caps help diversify portfolios, but risk-aversion is often too much to overcome. This has been most evident in the wake of the 2008-2009 financial crisis. However, focusing on performance since price is what pays, you may be surprised by how well small caps perform in bear and bull markets.
The Russell 2000 Index is the most popular benchmark used to track the performance of small-cap stocks. The index is comprised of the smallest 2,000 names within the broad-market Russell 3000, with the remainder representing the large-cap Russell 1000. Although the Russell 2000 only accounts for about 9% of the weight of the Russell 3000, it performs surprisingly well when compared to the Russell 1000.
Research from Nationwide and Factset Research Systems finds the Russell 2000 averaged a decline of 34% during recent bear-market periods (defined as a 20% decline without a 20% rally). In comparison, the Russell 1000 averaged a decline of 33%, only slightly better than the small caps. Furthermore, small caps truly out-shined large caps during bull markets. The Russell 2000 averaged 121% returns versus only 92% for the Russell 1000. The bear and bull market periods ranged from 2000 to 2013. Although, more recently, the Russell 1000 returned 13.2% in 2014 while the Russell 2000 returned 4.9%.
Past performance is no guarantee of future results, but adding small caps to a portfolio is simply another step of the diversification process. Fortunately, there is a variety of mutual funds that allow investors to capture small-cap exposure without picking individual companies they know little about.
This is a sponsored post written by The Cheat Sheet on behalf of Nationwide®.
This information is general in nature. It is not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. We encourage you to seek the advice of an investment professional who can tailor a financial plan to meet your specific needs.