For decades now, small-cap stocks have yielded great returns. In fact, data shows these have been victorious over several time periods. Let’s examine the historical background of small-cap stocks.
Small-cap Stocks: Historical Background
Experts consider small-cap stocks riskier than large-cap value stocks. However, it’s no surprise that they also yield better results. They are considered the riskiest but yield the maximum long-term return.
Experts regard small-cap stocks as the most consistent high performers in the investment space. They yielded decade-long returns that exceeded 12.5% except for the 1930s. Small-cap stocks emerged as the winners in the 1960s. They also drew much attention from year 2000 to the year 2009.
Dimensional Fund Advisors have been releasing their matrix book annually, presenting the historical returns and risks of indexes based on the market cap. In their annual matrix book, the small-cap value index is the best performing index over a period spanning 8 decades from 1931 to 2010.
Small-cap stocks come with their own risks, without a doubt, but they have also emerged as the winners over 50, 10, 5, and 1 year periods. As Eugene F. Fama puts it, you can only increase your expected returns by opening up to greater systematic risks. Volatility concerns are often over exaggerated. A study found that a portfolio that comprises only large-cap stocks had the same risk profile as another one with 30% small-cap, 30% mid-cap, and 40% large-cap investments. However, interestingly, such a diverse portfolio had a yearly return of around 2.1%. This clearly shows how investors could get greater annual returns by diversifying their portfolios and including small-cap companies at no additional risks.
Lessons from History
It is important to remember that it is really impossible to make predictions in the stock market: we can never know for sure which asset class will emerge as the winner next.
Experts have, time and again, stressed the need to invest all of the asset classes to diversify your portfolio. However, portfolio diversification is not as easy as it seems. You need to consider the market cap of the stocks, the fact whether they follow a value or growth orientation, and last but not least, a mixture of both foreign and US stocks.
The importance of investigations and research cannot be overemphasized. Make sure you conduct your research well when investing in small-cap stocks.
History teaches us important lessons. Ultimately, small-cap stocks make great investments if you know how to use them the right way. While we might never be able to precisely predict the future performance of stocks, we can always look at the historical performance of the various stock types and use those indicators to improve our decisions. Those who do not learn from history are, after all, doomed to repeat it!