Critical Reasons to Invest in Small Cap Stocks

When it comes to investing, you need to make sure you have a well diversified portfolio so that you can lower your risk. A great way to add diversification to your portfolio is with small cap stocks. But the benefits of small cap stocks don’t end with just diversification.

There are many great reasons why you should invest a portion of your money in small cap stocks. In this post, I highlight 3 critical reasons why investing in small cap stocks will increase your long term gains. But first, we have to make sure you understand what a small cap stock is.

What Are Small Cap Stocks?

Small cap stocks are stocks of companies that have a market capitalization between $300 million to $2 billion dollars. The smaller the market capitalization, the smaller the company. The smallest of small cap stocks are usually referred to as micro cap stocks. But for the purposes of this post, we will focus on small cap stocks in general.

While reading market capitalization might not make complete sense to new investors, as a comparison as of this writing, the market capitalization of Apple is $937 billion. The market capitalization of Amazon is $770 billion. As you can see, the variance between small and large cap stocks is great.

Now that we know what a small cap stock is, let’s start looking at the benefits.

3 Reasons Small Cap Stocks Are Important To Invest In

#1. Diversification

As I stated earlier, small cap stocks allow you to further diversify your portfolio to lower your risk. This is important because the more exposure you have to various sectors and stocks with various market capitalization’s, the lower your overall risk.

Therefore, it makes sense as an investor to invest is not only large cap stocks, but also small cap and international stocks as well. In fact, to have the greatest diversification, when investing overseas, you should be investing in both small and large cap stocks as well. In most cases, small cap international stocks are referred to as emerging market stocks.

#2. Higher Returns

Another great thing about small cap stocks is they tend to earn a higher return. This makes sense as they are growing at a faster rate than large cap stocks. Since small companies are earning higher revenues, investors are willing to pay higher prices for the growth. The result is higher stock returns for investors.

Of course, on the flip side is greater potential loss as well. This makes sense when you think about it. Apple is a large, well established company. It’s revenues are predictable and as a result, its stock price is going to slowly move higher or lower for the most part.