The stock market is a continuous cycle of ups and downs. There are usually more ups than downs, but there will always be both at some point. This seems to be the only certainty in a market notorious for its uncertainty.
Although the three main indices – the S&P500, Dow JonesAnd Nasdaq Compound – are up so far in 2023, the past year in the stock market has been largely defined by a bear market. No one can say for sure when there will be another bull market, but one thing is certain: it will eventually happen. And one of the best things investors can do is put themselves in a position to take advantage of it.
One of these ways is to stock up on Russell 2000 ETFs. Let’s see why.
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The role small caps can play in your equity portfolio
Small cap companies have a market capitalization between about $300 million and $2 billion. When it comes to investing, there is generally an inverse correlation between size and risk. Large-cap companies (those with a market capitalization over $10 billion) generally have more resources at their disposal, so they are normally more stable. However, it is because of their large size that their growth potential is often much lower than that of small businesses.
Small-cap companies are more prone to volatility and more sensitive to economic conditions, but their smaller size leaves them with greater upside potential. Where there is plenty of room for a business to grow, there is money to be made for investors who follow suit.
The Russell 2000
The Russell 2000 is an index that tracks the world’s 2,000 smallest companies. Russell 3000. It is considered the benchmark for small cap stocks, similar to the S&P 500 for large-cap stocks. Since there is more risk in investing in small capitalization companies, investors can do themselves a favor and minimize some of the risk by investing in a large Russell 2000 ETF.
Although the Russell 2000 ETFs follow the same index, they will have variations, such as the number of shares held and the cost. For example, the Vanguard Russell 2000 ETF (VWO 0.18%) contains 1,941 companies and has a 0.10% expense ratiowhile the iShares Russell 2000 ETF (IWM 0.15%) contains 1,925 companies and has an expense ratio of 0.19%. Overall, you can’t go wrong with the Vanguard ETF due to its low cost.
The Vanguard 2000 ETF also offers diversification, containing companies from 11 major sectors. The top five sectors are financials, healthcare, industrials, consumer discretionary and technology, and they make up just under three-quarters of the fund.
The wind will often turn
During bear markets and in times of economic uncertainty, investors generally turn to large-cap companies because of their relative stability. This is why small cap stocks tend to be short term during bear markets. However, the opposite also tends to be true. During bull markets, small cap stocks will often outperform large cap stocks.
Take the bull market that happened at the start of the COVID-19 pandemic. From April 2020 to the end of 2021, the Russell 2000 outperformed the S&P 500. Yet, during last year’s bear market, the Russell 2000 saw its value drop significantly lower than the S&P 500. The same is true. is produced during Great Recessionthe Russell 2000 falling more than 46% from September 2008 to March 2009, then doubling in value less than two years later.
You can’t guarantee this trend will continue, but now might be a good time to take advantage of lower prices and get some “discount” shopping. The Vanguard Russell 2000 ETF is down more than 28% from its November 2021 highs, and if you haven’t already, it might be time to start (or start rising) your bet.
You shouldn’t want a large portion of your stock portfolio to be in small cap stocks because of their volatility and risk, but you should give yourself some exposure to benefit from their growth potential. A good rule of thumb would be to have 5-15% of your stock portfolio in small cap stocks, depending on your risk tolerance and how close you are to retirement. The closer you get to retirement, the fewer small cap stocks you should need in your portfolio.
stefon walters has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.