Small-cap funds vs. large-cap funds: How they differ
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Small-cap funds and large-cap funds are two of the most popular ways to slice and dice the investment universe. Small-cap funds are those that invest exclusively in "small caps," or companies with a relatively small market capitalization, which is the total value of the company's outstanding shares. In contrast, large-cap funds invest only in "large caps," or the biggest publicly traded companies.
That's the key distinction between the two types of funds, but investors really need to know how these funds could perform in their own portfolios and why they should invest in them.
Small-cap funds or large-cap funds will perform, generally, like their holdings. For example, small cap stocks tend to be more volatile than large cap stocks, and so too are small-cap funds. So it can make sense to understand some of the characteristics of each type of stock.
It's important to note the differences between small caps and large caps, but when they're combined into a fund, some of those huge differences collapse a bit. For example, while an individual small cap may be quite volatile, a fund of small caps is much less volatile. Similarly, while an individual small cap can vastly outperform, a collection of small caps tends to perform better than a large-cap fund, but the difference is less dramatic.
Below is data from Portfolio Visualizer comparing the performance of large-cap stocks to small-cap stocks from 1972 through May 2022. This data provides an idea of how a fund composed of these market segments would have performed.
Performance, 1972-2022 | Large caps | Small caps |
---|---|---|
Total annual return | 10.5 percent | 11.5 percent |
Standard deviation | 15.3 percent | 19.6 percent |
Best year | 37.5 percent | 55.1 percent |
Worst year | -37.0 percent | -36.1 percent |
In 50 years, $10,000 becomes… | $1.52 million | $2.47 million |
Source: Portfolio Visualizer
Small caps performed better than large caps by a full percentage point, which doesn't seem like much at first. But over time that difference turns into a nearly $1 million difference in wealth. If you invested $10,000 in each category in 1972, it grew to $1.52 million in large caps but $2.47 million in small caps.
Those higher returns require a stronger stomach, though. The standard deviation for small caps shows these smaller companies have much greater volatility than their larger peers. But that volatility can also lead to individual years that vastly outpace the larger stocks. The best year for small caps saw them rise more than 55 percent, compared to 37.5 percent for large caps.
In recent years, large-cap stocks have meaningfully outperformed small-cap stocks, as tech giants such as Nvidia, Microsoft and Apple have accounted for a large portion of market returns. Over the past decade, the Russell 1000 Index, which is made up of large-cap companies, has seen annualized returns of about 12.4 percent, versus just 7.4 percent for the Russell 2000 Index, which is comprised of small-cap companies.
Given the performance of small caps and large caps, some investors might be tempted to put all their money in one or the other. But it makes more sense to balance your portfolio, with portions allocated to small-cap funds and large-cap funds – and mid-cap funds, too.
Here are some of the key issues to consider in weighting your portfolio to each:
While we've been discussing small-cap funds and large-cap funds as if they're uniform entities, there's huge variation in each of the categories. So, investors should look carefully at a fund's investments, its investment mandate, its track record and other specifics of each fund.
And sometimes winners keep on winning: the top funds can do well year after year, so it can make sense to check out lists of the best small-cap funds and best large-cap funds.
If you're investing in any kind of fund – small caps, mid caps or large caps – it's important to understand how the fund is managed. Broadly speaking, funds are managed in two ways:
While it may seem as if actively managed funds are going to be clear winners, it's actually very difficult for actively managed funds to consistently beat their passively managed counterparts. And it's not only in terms of performance that passive funds usually win: They usually have a lower expense ratio, making them lower cost for investors to own.
Most exchange-traded funds (ETFs) are passively managed, making them low-cost picks. Meanwhile, many mutual funds are actively managed, though not all. But in some cases, mutual funds are cheaper than their ETF cousins. Here's the breakdown of ETFs vs. mutual funds and what you need to know.
Small-cap funds can add some extra spice to your investment portfolio, helping to boost your overall investment performance over time. But you'll want to weigh that against the stability and still-attractive returns of large-cap funds. Finally, it's worth noting that investors should not assume all small-cap funds and large-cap funds are the same, so it's vital to look at the long-term track record of the funds as well as how much it costs to own the fund.
This story was originally published June 7, 2024, 12:18 PM.