Regardless of your investment objectives, having a diverse portfolio is a crucial element of achieving them. One of the ways you can potentially diversify your portfolio is to invest in various types of stocks. At that point, you might begin to consider investing in small-cap stocks.
Small-cap stocks may offer you more significant returns in a shorter timeframe but can also be volatile. Typically, by investing in small-cap stocks, you’ll be investing in growth companies.
What does “small-cap stock” mean?
Small-cap stocks are stocks in companies with a relatively low market capitalisation value. Market capitalisation is the market value of a company's outstanding shares.
One of the quirks of small-cap stocks is that there is no specific definition of what a small-cap means. However, so-called small-cap stock companies can have a market capitalisation from $300 million to $2 billion!
Small-cap stocks have historically delivered better returns than large-cap stocks across global markets. Still, they are also known as being more volatile and, therefore, a riskier investment type.
Potential advantages of small-cap stocks
There are several advantages of investing in small-cap stocks. While these are all attractive advantages, you should remember to seek independent financial advice before making changes to your investment approach and portfolio.
Large-cap trends tend to apply to small-cap stocks, making it easier to find opportunities
Several studies have shown that small-cap stocks follow the same trends as large-cap stocks and markets most of the time. If you're looking for small-cap opportunities, this might be a vital consideration, particularly if small-cap companies' coverage in the media is limited.
Look for trends and specific sectors where large-cap companies are starting to see a positive performance, and then cast your eye towards their small-cap equivalents.
More opportunity for individual investors
Due to the increased risk and market volatility, large investment houses don’t tend to invest in small-cap stocks to a significant degree. That means less competition and more opportunities for individual investors to buy small-cap stocks and reap the rewards if the price grows.
There is more room for growth in the market cap
Just because a company has a small market cap now, it won’t necessarily be that way forever. If you “get in at the ground floor,” so to speak, you will already be a stockholder when the company grows, its stocks become more popular, and demand for them grows.
What comes next? Higher stock prices and better profits on your investment.
Small-cap companies are often more attractive to buyers
Mergers and acquisitions are a typically complicated business. Large companies can also be tough to operate and foster innovation and change. It is becoming increasingly common for larger companies to buy smaller companies who are doing something extraordinary rather than creating their own departments to replicate their success.
If you’re a small-cap investor and such a buyout happens, your investment will look incredible!
Small-cap stocks can move the needle quicker
When Apple announces its latest iPhone, it registers with the markets. However, everyone knows what you're going to get with an iPhone. As such, Apple's announcements don't move the needle too much. In contrast, a big announcement coming out of a small-cap business can make a far more significant splash. In turn, this can lead to quicker gains on your initial investment as interest and the stock price shoot up.
Small-cap stocks vs. mid-cap stocks
All the potential advantages of investing in small-cap stocks are set against the potential to invest in large-cap stocks. However, if you’re looking for a middle ground, you might consider investing in mid-cap stocks instead.
Mid-cap companies typically have a market capitalisation of between $2 billion and $10 billion. From an investment perspective, they combine small-cap companies' growth potential with the more stable pricing typically seen in large-cap stocks. They are a fantastic "middle ground" for helping diversify your portfolio and work towards your investment objectives.
Investing in small-cap stocks
Investing in small-cap stocks can be a fantastic opportunity to diversify your portfolio and give yourself the potential to experience fast growth. As with any investment, you should ensure you take financial advice and are fully aware of both the pros and cons of investing in small-caps, and ensure any investment fits your circumstances and objectives.
