One of my investing commandments is “Thou shalt diversify”. For the stock portion of your investment portfolio this means buying large company stocks and small company stocks from all over the world.
I recently reviewed a prospect’s investment portfolio.
She had a lot of different mutual funds in several different accounts. A mutual fund is a convenient way to buy a “basket” of many stocks or bonds. Because she had a lot of funds in a lot of accounts she thought she was well diversified, but she was not.
Nearly all of her holdings were US “large cap” mutual funds. Large cap means large company. “Cap” is short for “Capitalization” which is the dollar value of a company’s existing stock shares. Examples of large cap companies are Apple, Microsoft, Google, Johnson & Johnson – companies we’ve all heard of and may or may not love.
The definition of “small” varies, but generally it is a company with value of ≈$300 million to $2 billion. So we are not talking about Bill and Bob’s Backyard Widgets.
Companies like Coherent, Inc. “the world’s leading supplier of laser solutions” in Santa Clara, CA.
Or Knight Transportation a “truckload motor shipping carrier” in Phoenix, Arizona.
I recommend that nearly all investors own some “small cap” or small company shares (in the form of a mutual fund). Why do I recommend this? Well, as Willie Sutton said when asked why he robbed banks – because that is where the money is.
Over time small cap stocks have out-performed large cap stocks
If you invested one dollar in the S&P 500 in 1926 (the 500 largest US stocks), it would have grown to $6,021 by the end of 2016. Pretty good!
But if you invested one dollar in small cap stocks in 1926, it would have grown to $33,212 (!)
Small caps are a bumpier ride (meaning they are more volatile).
And they don’t outperform large caps every year. Which is why I don’t recommend you go all in on smalls. In fact, I don’t recommend you go “all in” on anything! Bringing us again to one of my investing commandments “Thou shalt diversify”.