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Have questions? Email Send your question to bfriedberg@smartasset.com

3 Reasons to Invest in Small-Cap Stocks

Small-cap stocks are securities that are tied to companies whose market values often fall between $300 million and $2 billion. Adding some of them to your investment portfolio could be a good idea, especially if you’re interested in building long-term wealth. If you usually invest in large-cap stocks, here are three reasons to consider throwing some small-cap securities into the mix.

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1. Performance

When the market’s making big moves, it’s often the stocks of larger companies that get the most attention. If the price of Google or Apple takes a serious nose dive, for example, it’ll likely make headlines. What the headlines often overlook, however, is the fact that small-cap companies can match or even beat the performance of large-cap stocks over time.

Between 1979 and 2015, small-cap stocks in the Russell 2000 index outperformed large-cap stocks in the S&P 500 20 times within 37 years. In terms of the average annual return on investment, small- and large-cap companies’ stocks were virtually neck and neck, with the S&P 500 paying investors back 11.7% annually versus the 10.3% annual returns generated by the Russell 2000 index. In the long run, investing in smaller cap stocks may be just as profitable (if not more profitable) than investing in larger ones.

2. Growth Potential

3 Reasons to Invest in Small-Cap Stocks

Compared to their larger counterparts, small-cap companies also tend to be in a better position when it comes to growth. Someone who’s investing in small-cap stocks has a chance to get in on the ground floor before a company explodes in size and its stock value skyrockets.

For investors, there’s no room to go but up, assuming the company you put money into ends up being successful. If you can buy small-cap stocks at low prices, there’s a chance that you could collect a tidy profit later on if the companies you invest in grow.

Related Article: What Is Growth Investing?

3. Diversification

Diversification is important because it allows investors to spread out the amount of risk they’re taking on. Having a diverse portfolio can also provide you with some insulation from market volatility. If you’re primarily investing in mutual funds, for example, you could be missing out on the chance to invest in other kinds of assets.

Mutual funds often don’t allow investors to put money into small-cap investments. By investing in small-cap stocks directly, you can create some balance in your portfolio that may not have been there before.

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Know the Risks of Small-Cap Investing

3 Reasons to Invest in Small-Cap Stocks

While there are some benefits to investing in small-cap stocks, there are drawbacks too. Before you begin funneling cash into a stock it’s best to know what you’re getting yourself into. Small-cap stocks tend to be more volatile than large-cap stocks. That means that over the course of a trading day, the stock values can climb and fall.

If seeing the prices of your investments fluctuate isn’t something you can stomach, small-cap stocks may not be the best assets for you to invest in. As you’re researching small-cap stocks or small-cap stock funds, it’s important to read over each prospectus carefully. And remember, past performance is no guarantee of future returns.

Photo credit: ©iStock.com/Yuri_Arcurs, ©iStock.com/peshkov, ©iStock.com/Joshua Hodge Photography

Rebecca Lake Rebecca Lake has been writing about the nuts and bolts of personal finance for nearly a decade. She is an expert in investing, retirement and home buying topics. Her work has been featured on The Huffington Post, Business Insider, CBS News, U.S. News & World Report and Investopedia. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.
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