Those new to investing in the stock market tend to focus on large cap companies instead of small cap ones. However, Maria Ohle explains that there are plenty of reasons why one should consider investing in small cap stocks with a market value of under $2 billion.
Historically speaking, small cap stocks tend to outperform their larger counterparts due to their often innovative nature. They also have a vast potential for growth, even if many are still in their early stages. This means that small cap stocks can result in major returns for investors, especially when investing at an early stage.
Things to Be Aware Of
Before you start investing, there are a few negatives that you should be aware of. Firstly, small cap stocks are a riskier investment compared to bigger cap stocks. An article from FXCM explains that while they tend to outperform their larger counterparts during economic recoveries, they also tend to be weaker during economic downturns. This is because the companies lack the financial resources that bigger corporations possess during less prosperous times. As such, choosing a combination of small cap mutual funds and ETFs can help mitigate the risk.
In addition, it tends to be a bit more of a challenge to invest in small cap stocks due to the lack of information available. For instance, you might have to do more research to evaluate the potential of a small cap investment, without having access to a substantial history of pricing trends or earnings reports.
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How to Invest in Small Cap Stocks:
1. Decide How Much Capital You’re Willing to Invest
If you’re just starting out, devoting all your capital to small cap stocks is generally inadvisable. In an article by Jessica Saini, she writes that experts generally suggest investing less than 10% of your money in small cap stocks. This way, you’ll be able to better mitigate your losses.
2. Do Your Research on the Company
To find hidden small cap stocks, some extra effort is necessary. Taking advantage of price dips and using online tools can be very beneficial when it comes to timing it just right, as you adjust your portfolio over time. A feature from CNBC suggests using certain criteria, such as those with a market cap under $500 million, year-over-year revenue growth greater than 10%, one-year EPS growth greater than 15%, P/E ratio of 15 or less, and coverage by two or fewer analysts.
3. Stick to a Clear Strategy
When it comes to making successful investments, having a clear strategy is the key. During times of uncertainty, Business Insider suggests staying true to your strategy despite what the headlines are saying about small cap stocks. Sticking to your long-term goals as long as you have a sound financial plan, and avoiding impulse decision-making is the way to go. Given time, your portfolio is likely to recover, and you’ll see the value of your small cap stocks.
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4. Diversify Your Portfolio
You’ve probably heard this advice before, but it still holds true for small cap stocks. When you’re investing, you should try to ensure that your portfolio is a combination of small and large cap stocks. Having a combination of growth and income stocks is important to reduce large losses. US News notes that a good sign of diversification in your portfolio is “if some of your investments are up while others are down.”
Ultimately, small cap stocks come with their own sets of risks and benefits when it comes to investing. Doing substantial research and consulting with a financial expert can help guide you towards making intelligent decisions.
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