Investing is an awesome way to build wealth. You've probably heard the phrase “making your money work for you” and investing in the stock market can help you do exactly that.
But with so many people heeding this advice, the general stock market has become a little… saturated, to say the least. If you're looking for an alternative to general stock market funds, this post has got you covered with the best small-cap ETFs.
Small-cap ETFs are like regular ETFs but instead filled with small-cap stocks. Put simply, a company's market capitalization is how much it is worth. The more money a company is worth, the bigger its “cap.”
For example, Apple and Google are both large-cap companies / large-cap stocks. On the other hand, a smaller, unknown company might be classified as a small-cap.
In this post, you'll learn about the advantages of small-cap ETFs, pros, and cons, and also 5 of the BEST ones on the market today.
Before we dive in, however, it's important to remember that past performance is no guarantee of future results/investment returns (this is NOT investment advice). Furthermore, every investment decision you make should be done only after lots of personal research. Got that in mind? Let's jump in!
Why Small Cap Over Large Cap?
When you consider that small-cap companies are so unknown, you might be wondering, “Why should I invest in small-cap companies over large-cap companies?” Great question.
Historically, large caps like Google, Costco, or Apple have performed very well. But, there are two great reasons why you might want to consider small-caps:
- Growth potential
The first reason you might look into small-cap stocks is that they provide necessary diversification to your portfolio.
As T. Rowe Price puts it, “When picking a list of growth stocks for long-term investment, broad diversification of the risk is the first and most important principle to follow. No one can look ahead five or ten years and say what is the most promising industry or the best stock to own.”
With small-cap stocks, you can diversify your portfolio away from all the heavy players that dominate everyone else's portfolios.
The second (probably more important) reason behind small-cap stock investing is growth potential.
Large-cap stocks are well-established, yes, but that also means they are typically all very mature.
Think about it.
Is it easier for a $100 billion company to go to $1 trillion, or for a $10 million company to go to $100 million? The growth potential for small-cap companies is much greater than large-cap companies. THIS is the real reason why small-cap ETF investing can be so powerful.
Small Cap ETF Pros and Cons
Regardless of whether you're investing in mutual funds, value stocks, or small-cap ETFs, it's important to consider the advantages and disadvantages of each decision you make before putting any money to work. Here are all of the pros and cons of small-cap ETFs.
- More growth potential – as already mentioned, small cap stocks have much more room for growth than large cap stocks. What this means is that your upside for your capital is much greater with small cap investing.
- Less competition – with small cap stocks being something of an “underdog,” there's a lot less attention paid to them. What this means is you aren't competing with all the big institutional investors like hedge funds, private equity funds, and mutual funds when you invest in small stock companies.
- Better returns – historically, small cap stocks have had quite a high return in comparison to large cap stocks. Of course, the total return is not reflective of what your market price returns will look like, but it's still reassuring to see.
- Liquidity – compared to other larger companies, small cap companies are less well-known. This can be an advantage but it also means that there are less people actively trading the stock…this, in turn, results in less liquidity for you as an investor.
- Volatility – the potential for high returns has a price: market volatility. The current performance of a small cap company could be great one day, then suddenly very poor the next. There is a much lower chance of possible loss of principal with a large cap company like Google or Costco.
- Transparency – smaller companies tend to have less information publicly available for potential investors. This means there is a greater risk that you're exposed to blind spots in your investment decisions.
5 Best Small Cap ETFs
If you've gone through the pros and cons of small-cap ETFs, reviewed your thinking with a financial advisor, and decided you want to move forward with investing, here are 5 of the best small-cap ETFs that you can buy in 2021. (Keep in mind that I did not rank these based on any Morningstar Rating Metrics or weighted average of the performance figures or using any performance data; these are all personal opinions).
- Assets Under Management / Net Asset Value: $16.51B
- Expense Ratio: 0.04%
- Average Daily Volume (fund shares traded per day): 422,487
- Total Return (To Date): 299%
- Issuer: Schwab
- Assets Under Management / Net Asset Value: $68.64B
- Expense Ratio: 0.06%
- Average Daily Volume (fund shares traded per day): 3,445,858
- Total Return (To Date): 526%
- Issuer: iShares
- Assets Under Management / Net Asset Value: $577.21M
- Expense Ratio: 0.15%
- Average Daily Volume (fund shares traded per day): 12,079
- Total Return (To Date): 355%
- Issuer: Vanguard
- Assets Under Management / Net Asset Value: $172.28M
- Expense Ratio: 0.39%
- Average Daily Volume (fund shares traded per day): 7,960
- Total Return (To Date): 249%
- Issuer: Invesco
- Assets Under Management / Net Asset Value: $63.67M
- Expense Ratio: 0.40%
- Average Daily Volume (fund shares traded per day): 7,568
- Total Return (To Date): 159%
- Issuer: Invesco
Recap of the Best Small Cap ETFs
Small-cap ETF investing is a great way to diversify your portfolio away from large United States-based companies. Furthermore, with small-cap ETFs, you also have more upside potential.
Some of the pros to small-cap ETF investing are:
- Growth potential – there is more room for small-cap ETFs to grow than large-cap ETFs.
- Less competition – you won't have to compete with megafunds.
- Better returns – historically, small-cap funds have performed better than large cap funds.
Conversely, some of the cons are:
- Liquidity – you may have trouble liquidating your position when the time comes.
- Volatility – the greater volatility of small-cap stocks means there's no guarantee you'll get your original cost back.
- Transparency – smaller companies may not provide as much information about their operations as larger companies.
To save you from reading through each fund's prospectus and summary prospectus, here are 5 of the best small-cap ETFs you should check out!
- Schwab US Small-Cap ETF
- iShares Core S&P Small-Cap ETF
- Vanguard S&P Small-Cap 600 Growth ETF
- Invesco S&P SmallCap Momentum ETF
- Invesco S&P SmallCap 600® Equal Wt ETF
As always, make sure to watch out for taxes and brokerage commissions before placing your final order. Also, try to get clear on what each fund's investment objectives are. Other than that, happy investing! Who knows, maybe one of these ETFs will make you a billionaire someday!