Large-cap and small-cap stocks each have a place in any investor's portfolio. You can acquire them either through the purchase of individual company stocks or with an investment in mutual funds dedicated to different capitalization size. Once you understand the respective benefits of both kinds of stock, you can evaluate just how much you'd like to put into each type.
Market Capitalization Basics
“Cap” is short for capitalization. A company's market capitalization is its market value, which is the product of its number of outstanding shares times its current share prices. Stocks are generally categorized as large cap, mid cap or small cap.
Size Does Matter
Large-cap stocks are in companies worth $5 billion or more. These companies are likely to be household names like General Electric, McDonald's or Apple, and their shares also also referred to as blue chip stocks. Mid-cap stocks are medium-sized companies worth between $1 and $5 billion, which include familiar favorites like Netflix and Aeropostale. Small-caps are companies below the $1 billion threshold. A billion dollars may not seem “small,” but in the world of market capitalization it is the dividing line. Small caps have a further division called microcaps, which are very small companies worth just a few million dollars, traded over the counter rather than on stock exchanges.
Benefits of Large-Cap Stocks
Large-cap stocks companies have been around a while. They tend to be stable, and many of them pay dividends based on their earnings. Large-caps are widely considered to be an appropriate core holding in any investment portfolio. Consider them to be the main course of your investment meal. Sure, the dessert is tastier and more exciting, but without the main course you're not going to have a balanced meal. Large-caps may not see the triple-digit returns that the small-caps sometimes achieve, but they're also less likely to see the big downturns occasionally experienced by smaller companies. They can cause a hiccup time and again, but they form a strong foundation.
Benefits of Small-Cap Stocks
Small-caps can be the cherry on top of your stock holdings. Historically many small-cap stocks have outperformed the large-caps. On the other hand, the old saying “The bigger they are, the harder they fall,” however, doesn't quite apply to market capitalization. Small-caps tend to get pummeled in a bear market and take harder falls in those times than the large-caps.
Making a Decision
The question of small vs. large-caps is less an issue of choosing one over the other and more a question of how much of one to hold versus another. Institutional investors, like pension funds, insurance companies and similar organizations, tend to favor large-caps. Widespread institutional investment helps keep their prices stable and is one of the reasons they are a good core holding. Small-caps are a terrific opportunity for sharp growth, so you don't want to leave them out of your investment mix either. Young investors who aren't too fearful of taking some risk should include small-caps in their portfolios. If you have a bit of a gambling nature, you can also take a calculated risk with an investment in some microcap stocks, but make sure you research them before jumping in.
- business charts with buy image by Andrew Brown from Fotolia.com