Building a diversified portfolio means investing in a mix of large, stable corporations and smaller companies with growth potential. Here's what you need to understand about market capitalization and how it should inform your asset allocation strategy.
are shouting at us to buy and sell specific stocks on a daily basis if we want to get rich fast.
But is this the right approach? And is it even realistic?
Stock picking can be rewarding, but it’s a dangerous game if you don’t know what you’re doing. It’s also risky if you’re not investing enough money to be well-diversified.
As a new investor, you’re going to be better off investing in a broad mix of stocks and bonds. You can easily do this by putting your money into ETFs and mutual funds.
But where you do start? How do you know which investments are right for you? And what about asset allocation?
In this post I’ll break down the most common types of ETFs and mutual funds. I’ll also explain market capitalization and its importance to your investment strategy.
Finally, I’ll cover asset allocation and show you how to quickly build a diversified portfolio. Let’s first start by understanding market capitalization (also known as market cap).
What is market cap(italization)?
Before understanding the different types of mutual funds and ETFs, you need to understand market cap. Market capitalization is a quick way of determining how large a company is.
To calculate market cap, take the share price and multiply it by the number of shares outstanding (meaning shares that anyone can buy). This will give you a dollar amount, which is the company’s market cap.
Here are the most common names you’ll see, as well as their corresponding market caps:
- Large cap – $10-$100 billion
- Mid cap – $2-$10 billion
- Small cap – $250 million-$2 billion
For example, let’s say Company A has a stock price of $10 and has 1 million shares outstanding. Their market cap would be:
$10 x 100,000,000 shares = $1,000,000,000
So Company A has a market cap of $1 billion. According to the list above, this would make them a small-cap company.
Mutual funds and ETFs will often categorize themselves by the size of companies that they invest in. For example, a large-cap ETF will hold stock in only large-cap companies.
There are a few other types of market caps you may see, but not as often. They are: mega cap (> $100 billion), micro cap (< $250 million), and nano cap (usually <$50 million).
Further reading: Growth vs. Value Funds(Fidelity). Many funds will have “growth” or “value” in their name. This article will break these down so you can further educate yourself on choosing the right investment.
Why you should consider smaller companies for your investing strategy
Investing in small-cap companies is an important element ofyour investment strategy. Smaller companies tend to have a greater chance of large growth, faster.
For instance, a company with a market cap of $500 million is more likely to double in value than a company with a market cap of $500 billion.
Smaller companies also don’t have as much analyst coverage as large companies. This leaves room for smaller companies to go unnoticed. If you’re putting time into research, you can find smaller companies that are very profitable.
Lastly, small cap companies have theability to outperform large cap companies. This doesn’t come without risk, though.
There are some factors to consider before investing in smaller companies. Smaller companies are more volatile.
While you may get a larger return on your investment, you also open yourself up to more risk. Many smaller companies have not been around as long and may not last.
This is the beauty of small-cap ETFs and mutual funds. You don’t have to pick individual small companies to invest in. You immediately diversify yourself and invest in a basket of smaller companies.
So while investing in a small-cap ETF or mutual fund can be riskier than investing in a large-cap fund, it’s a necessary element ina diversified portfolio. Remember, rewards don’t come without risks in investing.
Ideal asset allocation (and how to choose)
One thing to consider is your own personal level of risk tolerance. Everyone’s asset allocation for stocks is going to be different based on the level of risk that they’re willing to take on.
The first thing to consider is your allocation between stocks and bonds. As a younger investor, you have the ability to take on more risk. This is because the timeline before retirement is much further out for you than somebody who is closer to retirement age.
Because of this, I recommend no more than 10% of your portfolio in bonds. The other 90% should be broken up into four fund classes: large cap, mid cap, small cap, and international.
The percentage allocation that I recommend is:
- 30% large cap
- 20% mid cap
- 20% small cap
- 20% international
- 10% bonds
This will give you a well-balanced and diversified portfolio and allow you to tap into foreign markets and have some bond stability.
There are also some services that will choose an asset allocation for you. This can be good if you’re unfamiliar with investing or don’t want to put the time into figuring out what’s right for you. The downside is that you lose the ability to choose a specific allocation of investments that fit your strategy.
Popular robo-advisors that can help you to create a balanced portfolio includeBettermentandWealthfront.For example, Wealthfront creates tailor-made diversified portfolios in just a few minutes. If you’d prefer a hands-on approach, you can also create a portfolio from scratch or customize a recommended portfolio. Wealthfront even includes automatic rebalancing and dividend reinvestment, and there’s no manual trading required.
Investments to get you started
Here are some well-known ETFs and mutual funds to look into as a starting point for your investment strategy:
- ETF: Vanguard Growth ETF (VUG)
- Mutual Fund: TIAA-CREF Large Cap Growth Fund (TILGX)
- ETF: iShares Morningstar Mid-Cap Growth (JKH)
- Mutual fund: T. Rowe Price Institutional Mid Cap Equity Growth Fund (PMEGX)
- ETF: SPDR S&P 600 Small Cap Growth ETF (SLYG)
- ETF: iShares MSCI EAFE Growth (EFG)
- Mutualfund: Fidelity Series International Growth (FIGSX)
- ETF: iShares Core U.S. Aggregate Bond (AGG)
- Mutual fund: Fidelity Total Bond (FTBFX)
It’s important to know the difference between ETFs and mutual funds, as well as their strategies, before investing. Also, understanding market capitalization is crucial before choosing your own investment strategy.
You also want to make sure you’re comfortable with your asset allocation so you’re not too heavily weighted in one asset class. This will help you keep a well-balanced and diversified portfolio.
Ready to build a diverse portfolio?Here are some tools that can help make it easy:
- Betterment SmartDeposit: A new way to automate your investing
- Personal Capital: A powerful free app for analyzing your portfolio
- Wealthfront: Online investment management
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To find an appropriate investment mix for your time horizon, find your age and the corresponding portfolio allocation. A typical mixture could include 60% large-cap (established companies), 20% mid-cap/small-cap (small to medium-sized compa- nies), and 20% international (companies outside the U.S.) stocks.Which is better small-cap mid cap or large-cap? ›
Mid-caps are slightly riskier than large-cap stocks and less risky than small-cap stocks. Small-cap stocks are riskier than the other two. Despite the risk, these stocks have great growth potential. Large-cap funds are usually less volatile unless there is some news.How much should I allocate between large mid and small caps? ›
You can start with 50 percent of your stocks in large-caps, 30 percent in mid-caps, 20 percent in small-caps. Adjust from there according to your risk tolerance. For example, if you want more growth, you could go with 40 percent large-caps, 40 percent mid-caps and 20 percent small-caps.Should I invest in small-cap or mid cap? ›
Mid-cap stocks generally fall between large caps and small caps on the risk/return spectrum. Mid caps may offer more growth potential than large caps, and possibly less risk than small caps. Small-cap stocks tend to be, on average, least developed publicly traded companies, although there are exceptions.What percentage should I invest in small-cap? ›
According to the Securities and Exchange Board of India (SEBI), small-cap schemes need to invest at least 80% of their total assets in small-cap companies.How much should I allocate to small-cap stocks? ›
Over the long run, small caps tend to outperform large-cap stocks, so an individual with a 5 to 10-year investment horizon should be comfortable investing 10% to 20% of their portfolio in small-cap stocks, Chan says. "As a result, having long-term exposure to (small caps) is a good investment decision," he says.Which cap is best to invest? ›
- Axis Growth Opportunities Fund.
- Mirae Asset Emerging Bluechip Fund (SIP capped at Rs 2,500)
- Canara Robeco Emerging Equities Fund.
- Sundaram Large and Midcap Fund.
- Kotak Equity Opportunities Fund.
- Invesco India Growth Opportunities Fund.
Small-cap stocks have historically outperformed their larger counterparts, but investment into this asset class should be approached with caution and suitable risk tolerance. They tend to offer higher returns in exchange for higher investment risk.Which cap is best for mutual fund? ›
|Mutual fund||5 Yr. Returns||3 Yr. Returns|
|ICICI Prudential Bluechip Fund - Direct Plan - Growth||12.3%||14.88%|
|Kotak Bluechip Fund||10.84%||14.79%|
|UTI Master Share||11.18%||14.61%|
|SBI Blue Chip Fund - Direct Plan - Growth||11.07%||14.6%|
Small cap mutual funds: Up to 2. Given how high the risk is with these mutual funds, it is best to limit yourself to a limited number of small cap mutual funds. Also, avoid putting in a great percentage of your total mutual fund investment in small cap mutual funds. Debt funds: Ideally 1, but 2 is also good.
On average, small-caps have an advantage when the U.S. economy is in recovery mode. When the economy is rebounding, unemployment rates are quickly going down, and businesses are seeing strong earnings growth, making it a great time to invest in small-cap stocks. Of course, small-cap stocks don't always outperform.How do you diversify a portfolio? ›
To achieve a diversified portfolio, look for asset classes that have low or negative correlations so that if one moves down, the other tends to counteract it. ETFs and mutual funds are easy ways to select asset classes that will diversify your portfolio, but one must be aware of hidden costs and trading commissions.Why are small caps doing so well? ›
The primary advantage of investing in individual small-cap stocks is the significant upside growth potential that is unmatched by larger companies. Small-cap value index funds also offer a way for passive investors to boost returns. Merger and acquisition activity provides another opportunity for small-cap investors.Are small caps undervalued? ›
After months of underperformance compared with large caps, U.S. small caps stand out as an undervalued segment of the market, Jonathan Golub, chief U.S. equity strategist & head of quantitative research at Credit Suisse Securities, wrote in a note Monday.Who should invest in small-cap funds? ›
3. Who Should Invest in Small Cap Funds? People who are ready to take some risks in order to make the most of their portfolio should think of investing in small cap mutual funds. These funds are known to offer high returns when the market is bearish.Is small-cap high risk? ›
Small-cap companies tend to be riskier investments than large-cap companies. They have greater growth potential and tend to offer better returns over the long-term, but they do not have the resources of large-cap companies, making them more vulnerable to negative events and bearish sentiments.Which small-cap is best? ›
|S. No.||Name||AUM (Rs in cr.)|
|1.||Quant Small-Cap Fund||1,753.58|
|2.||BOI AXA Small-Cap Fund||296.55|
|3.||Canara Rob Small-Cap Fund||2,514.25|
|4.||Kotak Small-Cap Fund||7,384.60|
The laggards in the category are:
- ITI Small Cap Fund: 33.26%
- SBI Small Cap Fund: 44.74%
- IDFC Emergency Business Fund: 48.78%
- ABSL Small Cap Fund: 49.04%
- UTI Small Cap fund: 54.23%
|Fund Name||Fund Category||5 Year Return (Annualized)|
|Kotak Small Cap Fund||Equity||17.84 % p.a.|
|Nippon India Small Cap||Equity||17.72 % p.a.|
|ICICI Prudential Smallcap Fund||Equity||15.56 % p.a.|
|Axis Small Cap Fund||Equity||19.75 % p.a.|
Mid Caps Dominate in Long-Term Performance
However, the longer mid-cap stocks are held, the more often they outperformed. In fact, 71% of the time, mid-caps outperformed small- and large-cap stocks over any 10-year rolling period in the past 20 years.
|Fund Name||Category||1Y Returns|
|PGIM India Flexi Cap Fund||Equity||0.9%|
|Bank of India Tax Advantage Fund||Equity||-1.1%|
|Quant Large and Mid Cap Fund||Equity||14.5%|
|Parag Parikh Flexi Cap Fund||Equity||3.5%|
1) Axis Bluechip Fund Direct-Growth
Axis Bluechip Fund Direct Plan-Growth is an Equity Mutual Fund Scheme launched by Axis Mutual Fund and is the Highest Return Mutual Fund in Last 5 Years.
Best-performing U.S. equity mutual funds for July 2022.
|Ticker||Fund Name||5-Year Return|
|LCSTX||ClearBridge Sustainability Leaders Fl||13.52%|
|PBFDX||Payson Total Return||13.40%|
|PAXLX||Pax Large Cap Fund Individual Investor||13.02%|
|JEQIX||Johnson Equity Income||12.20%|
Your monthly income minus the expenditures should determine the number of goals you should accommodate. If you have 10 life goals such as retirement, car, wedding, vacation etc. and you invest in one SIP for each of them.Can you have too many mutual funds? ›
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea. The addition of too many funds simply creates an expensive index fund.What are the 2 funds for life? ›
The “Two Funds for Life” portfolio suggests 90% Target Date Funds (picked for your time horizon) and 10% Small Cap Value. That's a strategy that delivers two things all investors should value: simplicity and low-cost diversification.Do small caps lead the market? ›
Smaller companies (small caps) tend to be more sensitive to changes in the economy than larger companies (large caps). As a result, small-cap shares have historically sold off faster during a recession, leading to rapidly deteriorating returns for those stocks.Should I put all my money into stocks? ›
As a young person, you might decide to invest all of your money in stocks due to the higher returns. Your portfolio will be more volatile, but overall you should see a greater return in the long run. Then as you get older, you can diversify and allocate some of your money into bonds or other investments.What does a good portfolio look like? ›
A diversified portfolio should have a broad mix of investments. For years, many financial advisors recommended building a 60/40 portfolio, allocating 60% of capital to stocks and 40% to fixed-income investments such as bonds. Meanwhile, others have argued for more stock exposure, especially for younger investors.How many stocks is good for diversification? ›
Some experts say that somewhere between 20 and 30 stocks is the sweet spot for manageability and diversification for most portfolios of individual stocks. But if you look beyond that, other research has pegged the magic number at 60 stocks.
Typically, a balanced portfolio has a 50/50 or 60/40 split between stocks and bonds. And because you have a mix of stocks and bonds, you are balancing your risk level — and your possible return on investments. Having a balanced portfolio means striking a balance between preserving your capital and achieving growth.How do you know if a small-cap stock is good? ›
- Financial strength of the company. The share price of a company rises when it has a sound financial background. ...
- Rising sales and profits. Small cap companies have low cash reserves. ...
- High operating margin. ...
- Quality of management.
- Top 10 Stocks To Consider in 2022. ...
- Stocks With Growth Potential for 2022. ...
- Lithia Motors Inc. ...
- Travel + Leisure Co. ...
- Mueller Industries Inc. ...
- First BanCorp (FBP) ...
- Herc Holdings Inc. ...
- High-Performing Stocks.
- Trends in earnings growth.
- Company strength relative to its peers.
- Debt-to-equity ratio in line with industry norms.
- Price-earnings ratio as an indicator of valuation.
- How the company treats dividends.
- Effectiveness of executive leadership.
That's why the American Association of Individual Investors recommends that investors allocate only 20% to 25% of their portfolio to large-cap stock. That said, your asset allocation could differ from these types of guidelines based on your risk tolerance and investment goals.What should be the ratio of large-cap funds in the portfolio? ›
Large-Cap Funds are mandated to invest at least 80% in Large-Cap Stocks and Mid-Cap funds are mandated to invest at least 65% in Mid-Cap Stocks. So if you choose to invest 50% each in Mid-Cap and Large-Cap funds, 100% of your money is invested in the top 250 companies in India.How much is large-cap vs small-cap? ›
Key Takeaways. Big-cap (large-cap) stocks have a market cap of $10 billion or more. Small-cap stocks generally have a market cap of $300 million to $2 billion. Small-cap stocks shouldn't be overlooked when putting together a diverse portfolio.Do mid-caps outperform large caps? ›
Mid Caps Dominate in Long-Term Performance
In fact, 71% of the time, mid-caps outperformed small- and large-cap stocks over any 10-year rolling period in the past 20 years.
Then, in order to diversify your money among the other investment categories, adjust the percentages that you got using the above rule of thumb as follows: Invest 10% to 25% of the stock portion of your portfolio in international securities. The younger and more affluent you are, the higher the percentage.Is small-cap high risk? ›
Small-cap companies tend to be riskier investments than large-cap companies. They have greater growth potential and tend to offer better returns over the long-term, but they do not have the resources of large-cap companies, making them more vulnerable to negative events and bearish sentiments.
Individual small-cap stocks offer higher growth potential, and small-cap value index funds outperform the S&P 500 in the long run. Small caps also experience higher volatility, and individual small companies are more likely to go bankrupt than large firms.Can you have too many mutual funds? ›
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea. The addition of too many funds simply creates an expensive index fund.