As a dividend investors, are you missing out on the potential higher returns? Dividend investing and dividend stocks are most often associated with large-cap stocks and can be easily ignored. However, it is important for all investors to consider various asset classes for their overall asset allocation, and this includes small-cap stocks.[ad#tdg-embedded]
What are the Characteristics of Small-Cap and Large-Cap Stocks
When an investor speaks of small-cap stocks and large-cap stocks, they are referring to the stocks market capitalization (or market cap). Market cap is the total dollar value of all of a company’s outstanding shares and is calculated by multiplying a company’s shares outstanding by the current market price of one share.
Although the definition can vary depending on whom you talk with, to be a small-cap stock, the market cap for the company will be between $300 million and $2 billion.
A large-cap stock on the other hand typically is defined as having a market cap of more than $10 billion.
Pros and Cons of Small-Cap and Large Cap Stocks
The pros and cons of both small-cap and large-cap stocks can be best presented in table format. Have a scan threw the following table to better understand them both.
Returns of Small-Cap Versus Large-Cap
To get to the point quickly, small-caps have typically outperformed large-cap stocks. In other words, there has been a premium to be had for the additional risk that investors take on when purchasing small-caps.
In the chart below (source), we can see the additional premium provided by small-caps. It is important to note that this chart compares small-cap value stocks with large-cap growth stocks, which are slightly different than what we are talking about here. The message has been the same however: small-caps have provided a premium to investors.
Which one is better for you?
If you are a dividend investor, or an ETF index fund investor then answer is still the same in my opinion. Most portfolios should incorporate a balance of both small-caps and large caps into their portfolio.
The addition of small-caps provides investors with the potential for additional returns, but with higher volatility. The large-cap stocks provide more stability with less returns, providing a more agreeable balance between risk and reward.
How to Invest in small-caps
To add a small-cap component to your portfolio, my suggestion has always been to use index fund or index ETFs to ensure adequate diversification. Small-cap stocks are much risker so by only buying one or two you are taking on a lot of individual security risk. With an index fund you are buying 1000’s of small-cap stocks.
If you still want to stick with the dividend focused theme in your portfolio, then you can have a look at the WisdomTree SmallCap Dividend Fund (DES), which tracks against the performance of the small-capitalization segment of the US dividend-paying market.