There’s change in the air. No, I’m not talking about the weather. I’m not referring to post-election politics, either. Instead, my point is about the stock market.
The S&P 500 delivered its best performance in a long time last week. Lower-than-expected inflation numbers gave investors something that they haven’t had in a while — hope.
In particular, they now have hope that the Federal Reserve won’t have to continue jacking interest rates up. And they have hope that the economy just might have a soft landing after all rather than entering into a recession.
It’s possible that a new bull market could be in its infancy. Here’s why now is a great time to buy small-cap stocks.
The magic of new bull markets
History shows that new bull markets tend to present great opportunities to buy small-cap stocks. Let’s look at a couple of examples.
The Russell 2000 is the most widely followed index that tracks small-cap stocks. It includes the 2,000 smallest stocks in the broader Russell 3000 index. Notice in the chart below how the Russell 2000 closely tracked the performance of the large-cap S&P 500 throughout much of the massive market sell-off during the Great Recession that began in late 2007 and went through mid-2009. (The shaded portion of the chart indicates when the U.S. economy was in a recession.)
Both the Russell 2000 and the S&P 500 began to rebound in the first half of 2009. That marked the beginning of the longest bull market ever. By 2010, which was still in the early stages of the new bull market, the Russell 2000 opened up a noticeable lead over the S&P 500. Small-cap stocks were outperforming large-cap stocks.
There was a somewhat different scenario in the new bull market preceding the one following the Great Recession. The Russell 2000 held up better than the S&P 500 did in the market downturn that occurred during and after the recession of 2001.
However, small-cap stocks again beat large-cap stocks in the subsequent bull market. By the end of 2004, which was still relatively early in this new bull market, the Russell 2000 was handily outperforming the S&P 500.
Any time is a good time
But what if a new bull market isn’t beginning right now? No problem. Any time is a good time to invest in small-cap stocks.
The bottom line is that small-cap stocks can turbocharge your portfolio. Over the long term, they outperform large-cap stocks. Just look at the comparison of the total returns of the Russell 2000 and S&P 500 since 2000.
Why do small-cap stocks tend to perform so well? For one thing, Wall Street analysts don’t follow small-cap stocks as closely as they do large-cap stocks. This allows many of these smaller stocks to quietly achieve success without being overvalued.
Smaller companies also have more room to grow than huge companies do. And they often grow the fastest when they’re smaller.
Ways to invest in small-cap stocks
You could buy individual small-cap stocks. Keep in mind, though, that they’re usually riskier than large-cap stocks. Be sure to research the companies’ financial position, management team, growth prospects, and competitive landscape before making a decision.
An easier alternative is to invest in an exchange-traded fund (ETF) that focuses on small-cap stocks. There are several of these ETFs to consider. I think that the Vanguard Small Cap Index Fund ETF (VB) especially stands out.
Vanguard is known for its low fees. Its VB small-cap ETF has an expense ratio of only 0.05%. The ETF holds positions in nearly 1,500 small-cap stocks, providing ample diversification. You don’t need to have a lot of money to get started with VB, either: Its minimum investment amount is only $1.
Maybe a bull market is about to begin. Maybe it isn’t. Either way, investing in small-cap stocks now should pay off nicely over the long run.
— Keith Speights
Source: The Motley Fool