If you own small company stocks or funds as a semi-permanent part of your portfolio, you’ll want to read on.

Well-meaning but ill-informed “experts” (people with something to sell) are coming out in droves, exuberant about how great small company stocks (small caps) are. Their stories are compelling. After all, “Walmart was a small company at one time.” And they claim that this market segment has been doing great since your grandfather was knee-high to a grasshopper. Therefore, the pitch goes, small stocks should be a core holding.

If this sounds familiar, your portfolio may have an Investment Vampire with a license to suck the efficiency out of your portfolio.

Lie, Damn Lie, or Statistics?

If you go back to WWII or earlier, you may be able to cherry-pick some data showing that small caps outperform.

However, from 1980 through 2000, small and large-cap stocks delivered virtually identical returns. Large did it with dramatically more safety. From 1980 through August of 2024, the S&P 500 outperformed the Russell 2000 small-cap index. And did it with more safety. Owning small caps delivered less return with more risk. And over the past 20 years (1/2004-8/2024), large stocks have outperformed small by more than 240%.

To add insult to injury, for the past 15 years, the small-cap index has underperformed the NASDAQ 100 by an average of about 8% points per year – each and every year! The NASDAQ has dramatically outperformed small caps with less volatility risk. (Source: Y-Charts, Luken Investment Analytics 2024)

Does Small Ever Make Sense?

Is the small-cap juice ever worth the squeeze?

In a word: possibly.

Results from small caps come from taking advantage of their volatility when they are down—in troughs. Since small caps tends to go down dramatically more than large during corrections, the best time to own them tends to be immediately following major recessions or significant market corrections. But results tend to move in fits and starts.

For example, during the depths of the Dot-Com Bust and the Financial Crisis, from 2003 to 2006, small delivered stellar returns and outperformed large by more than 50 percentage points over a 2+ year period, albeit with much more volatility than large. Starting in 2010, coming out of the liquidity crisis of 2008-09, small delivered about 1% more per year than large with about 20% more volatility for the next decade.

Market Conditions Changes. Your Portfolio Should, Too.

As market conditions change, so do opportunities to maximize your investments. That’s why your portfolio needs to adapt to the times.  What happened with small caps last year or since your grandfather was born has nothing to do with investing for the future—your future.

When it comes to small-cap stocks, we shouldn’t say “no, never.” But market data tells us to be cautious about this volatile asset class.

Sources: YCharts, Thompson Reuters.