But with a small cap stock, you risk losing a lot of money. This is because it is easier for a small company to have unpredictable revenues and even go out of business in a short period of time.

The good news though, is that by investing in high quality small cap mutual funds and exchange traded funds, you are buying a large number of small companies and diversify the risk of a couple losing revenues or even going out of business.

#3. Long Term Performance

Over the long term, small cap stocks tend to outperform large cap stops by 2.3% annually. Over the course of 10 years, with $10,000 invested, this could result in an additional $5,000.

Taking the above point further, from 1979 through 2015, small cap stocks outperformed large cap stocks 54% of the time. So by investing in small cap stocks, you have a good chance of earning a higher return over the long term compared to large cap stocks and you can do so on a regular basis too.

Final Thoughts

To be a successful investor, you have to make a point to invest a portion of your money in small cap stocks. It will help you to have a better diversified portfolio and earn higher returns.

But you have to take into account your risk tolerance when deciding how large of percent of your portfolio should be invested in small cap stocks. This is because of the point above about these stocks being more risky than larger company stocks. Since they tend to earn higher returns, they also tend to be more volatile as well.

But by finding the correct allocation for you needs, you can invest in small cap stocks, earn a higher return and not worry about risking your money to a greater potential loss.

This article has been republished with permission from Modest Money. 

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