For investors looking for a higher level of growth, but who can tolerate a bit more risk, investing in a small cap ETF like Vanguard Small-Cap Value ETF (VBR), could be a solid strategic diversification to an existing portfolio.

Small cap stocks are companies with a relatively small market capitalization, or market value of their outstanding shares. The definition of small cap can vary among brokerages, but according to Investopedia, it is generally a company with a market capitalization of between US$300 million and $2 billion.

As a general rule, small cap companies provide investors with more room for growth but also typically contain a greater risk profile and volatility than large cap companies. A large cap offering, which has a market capitalization of $10 billion or higher is usually a longer term play, but does offer a bit more stability.

Inside the Vanguard Small-Cap Value ETF (VBR)

The Vanguard Small-Cap Value ETF seeks to track the performance of a benchmark index that measures the investment return of small-capitalization value stocks.  The fund specifically aims to track the performance of the CRSP US Small Cap Value Index, where focus is on small-cap value equity. The CRSP US Small Cap Index includes U.S. companies that fall between the bottom 2%-15% of the investable market capitalization.. The ETF employs a passively managed, full-replication strategy, offering a very modest expense ratio, like other Vanguard sibling funds, at just 0.07%. The fund remains fully invested, and its low expenses minimize net tracking error.

Historically, U.S. small-cap stocks have outperformed large-cap stocks during rising interest rate environments. Periods of rising interest rates usually occur at the inception of an economic recovery, or at a time when it appears that the Federal Reserve will no longer decrease interest rates to stimulate the economy.

“Because they usually are young and lack exposure, small-cap growth companies tend to fly under the radar,” writes financial services company Federated Investors. “They are less closely followed and understood by the community of securities analysts, which sometimes means they sell for less than their true or potential value, creating opportunities if the market comes to re-price their shares accordingly.”

Another way to look at the best time to buy small-cap stock funds is when it seems that the market has been down for a long period of time, and it appears that there’s no optimism about the market, signifying a potential low point.

For more equity ETF plays, visit our Equity ETF Channel.

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