Small Cap vs Large Cap Mutual Funds
Small cap vs large cap funds
Most investors understand that mutual funds and ETFs are passive ways to invest. However, there are many different funds, like small and large cap funds. Additionally, these funds employ various investment strategies like value and growth.
The investment strategy you end up going with should depend on your risk tolerance and investment goals. Small cap stocks come with more risk but more reward potential. Large cap companies are more established, pay reliable dividends, and are therefore considered less risky.
What is a small cap stock?
A small cap stock is a company with a market cap from $300m to $2b. Small cap stocks are riskier than larger companies, but their future reward potential makes up for it. In addition, since small cap stocks are in the process of growing, they have a lot more growth potential than larger companies.
What is a small cap mutual fund?
Small cap mutual funds invest in a basket of small cap stocks and charge investors a fee to manage the allocations. Small cap funds are best for investors who want a passive higher-risk investment.
What is a large cap stock?
A large cap stock is a company with a market cap of $10b or higher. Large cap companies are generally more resilient to stock market volatility than small cap companies. Additionally, many large cap companies generate consistent cash flow and pay out dividends (or do share buybacks) to benefit shareholders.
What is a large cap mutual fund?
A large cap mutual fund invests in a basket of large cap stocks and charges investors a fee to manage the holdings. Large cap funds are common for investors to buy in their retirement accounts and 401ks.
Small cap vs large cap performance
The S&P 500 (large cap index) and the Russell 2000 (small cap index) are relatively similar in performance. However, over the last ten years, the S&P 500 has outperformed the small cap index by about 3%.
The small cap index generally performs the best in bull markets, while the large cap index will generally perform the best in bear markets.
Investors generally move to more speculation and risk-taking investments in a bull market since the whole market is moving up, and there is overall optimism. But smaller companies generally take a bigger hit during bear markets since many investors avoid risky investments since those companies might not have the resources needed to survive.
Outlier growth stocks
Investing in a growth stock that appreciates massively is an amazing way to build wealth. However, there is no guarantee that the growth stock you invest in happens to become successful.
A fantastic example of an outlier stock is Tesla. The electric car company grew massively in value over the last few years due to its growth and ability to eventually generate profits. The company went from unprofitable to profitable quickly, which caused investors to pile in and drive the stock price higher.
Value vs growth funds
In addition to small and large caps, there is also the ability to choose between value and growth funds. Investors generally consider small cap stocks growth investments, while many large cap stocks are considered value investments.
Small cap growth funds
Small cap growth funds invest in small cap companies with high growth potential. Growth stocks grow their revenue faster than the overall market, so their share price may increase more than the market average.
Growth investors are seeking capital gains rather than steady dividend payments and revenue. As a result, growth companies usually don’t pay dividends because they reinvest profits to drive innovation and growth.
Small cap value funds
Small cap value funds are interesting because many investors consider small cap companies to be growth stocks. However, there are various small cap companies that investors consider to be value investments and pay dividends.
Large cap growth funds
While many growth stocks are small cap, there are plenty of large cap growth companies and funds. A growth stock grows its sales and earnings faster than the market average, so plenty of large cap companies fit this definition.
Large cap value funds
Large cap value funds invest in large cap companies that generate reliable revenue and pay good dividend yields. Large cap value is probably the lowest risk equity investment you can make because the companies are reliable and resilient to volatility in the market.
Small cap vs large cap: Which is best for you?
Your job as an investor is to determine the investments that suit your overall financial goals. If you can’t decide, here are some questions you can ask yourself to help find out.
What is your risk tolerance?
If you have a high risk tolerance, you can invest your money into small cap growth mutual funds and equities. In addition, you can mix up large and small cap growth funds for more diversity.
If you have a low risk tolerance, you can invest in large cap value funds and enjoy your reliable dividend payments. However, even if you have a low risk tolerance, you can allocate a small percentage of your portfolio to small cap growth mutual funds.
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As Always: Buy things that pay you to own them.
-Josh
Blog Post: #038
