Now Is the Time to Squirrel Away Low-Cap Stocks
The S&P 500 tracks the 500 largest U.S. public companies and is the most popular stock market index, with many investors using it to gauge how well the overall economy is performing. The Russell 2000 is an index that tracks the smallest 2,000 stocks in the Russell 3000 and is largely used to gauge how well small-cap stocks as a whole are performing.
Large-cap stocks, in general, are considered more stable because of their size, but an S&P 500 fund is considered one of the most stable and consistent investments in the stock market. Like any other stock, it has its fair share of lows (it’s down over 17% YTD, as of July 26) and volatile swings, but in the long run, it’s historically been as trustworthy of an investment as an investor could hope for.
While many investors tend to gravitate toward large-cap stocks during bear markets and periods of uncertainty, now may be the time to prepare for the future and rack up low-cap stocks.
The tables will eventually turn
During bear markets, large-cap companies generally perform better than small-cap companies because they have more money and resources with which to weather the storm. There’s no guarantee that any company will survive a bear market or bad overall economic conditions, but larger companies have higher chances.
This stability, however, doesn’t mean large-cap stocks are exempt from drastic drops; they just typically drop less than small-cap companies. Since the beginning of 2022, the Russell 2000 has dropped over 20% compared to the S&P 500’s 17%.
Although small-cap stocks often get the short end of the stick during bear markets, they usually have more upside during bull markets when prices generally increase faster than they drop during bear markets (and for longer). From March 20, 2020 — around the time many companies saw their stock hit the lowest point of the COVID-19 pandemic — to the end of 2021, the Russell 2000 increased by 121%, while the S&P 500 increased by 106%.
The same is true following the Great Recession of 2008 to 2009. Following March 2009 lows, the Russell 2000 had returned over 100% by April 2010. The S&P 500 wouldn’t see 100% returns from March 2009 lows until February 2013.
Prep for the future
Investing in individual low-cap stocks is risky enough during “normal” stock market conditions, but there’s added risk during bear markets because of more uncertainty. Instead of taking on that added risk, one of the best things you can do is invest in a small-cap index fund — preferably the Russell 2000 (or at least a comparable index fund) that consists of many companies across all sectors. Doing so is basically investing in the low-cap market as a whole.
Past performance doesn’t guarantee future results, but it’s a good indicator. If you have time on your side, the Russell 2000 has proven it can rebound from down periods and produce good long-term returns. Instead of shying away from small-cap stocks right now, it should be the time to increase your stake and take advantage of the “discounted” prices.
You don’t want small-cap stocks to be the bulk of your portfolio, of course, but you should have some exposure to them. As long as they’re not too much of your portfolio, the chance for high growth often outweighs the risks that come with them.
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