February 5, 2014

What is the difference between a small-cap index fund and a large-cap index fund? Why should you care?

4 thoughts on “February 5, 2014”

  1. Alayna Duwa says:

    Large-cap index funds are focused on large corporations with very high market value. These are not very volatile and are very good for long-term investing, such as for retirement. Small-cap, on the other hand, are very volatile meaning the market rate changes a lot and if lookin at a graph it would look like you’re on a roller coaster. These funds are in companies that have a smaller market value(1 billion or less). At the moment large-cap are much more popular due to the stability of the funds. Also, the expense ratio for large-cap funds, on average, are lower.
    Why does this matter?
    Being the smart investor you are you have to think, is my goal to get rich today or being financially wealthy and free in the future, the long-run? If so, the large-cap investments will provide you with long-term higher gains than the small-cap funds.

  2. Garrett Haag says:

    A small cap index fund is an index fund that has mainly small growth companies in it, it may have companies like Kmart or other things no one knows about, the reason they are normally more volitile is because they are less known and people think they are sick and sucky, if a company like that does badly no one thinks any differently about it, but if it does good and no one thought it would, it would have a huge spike, you can sometimes get an average return of 12% with small caps, large caps are normally more reliable and well known companies like walmart, if they have a bad day, the stocks may crash or have a large drop, the index funds mainly focus on the two types of stocks and can give you a different return with a different risk. You are wise to have a mix of both of these index funds in your portfolio to gain the benefits of both and limit your market risk.

  3. Chris says:

    Small cap index fund means that the companies involved in this fund have a small market capitalization of $300 million to $2 billion. One of the biggest advantages of investing in small-cap stocks is the opportunity to beat institutional investors. One of the disadvantages is that some of these companies may fail, hence the higher risk.
    Large cap index means that the companies involved have a capitalization of over $10 billion (Apple, Microsoft, Wal Mart, GE, etc.). There is less risk involved in these companies, but the payout could potentially be smaller.

  4. Mike Finley says:

    I am so very impressed with the three answers. I will have to give some thought to who provided the best answer on this day. You three are going places! Now, let’s review what was mentioned.

    A Small-cap index fund owns small companies, many you have not heard of. Some are growth companies (fast growing) and some are value companies (a bit sickly and not so healthy). You can actually own either a small-cap growth index or a small-cap value index if you prefer one type over the other. This type of fund is quite volatile and should be considered a long term investment. It will have some big years and some crappy years. Keep that in mind.

    The large-cap index fund is very similar except the companies are much bigger. They also come in the growth vs. value variety. This type of fund is less volatile than a small-cap fund, but will also provide a roller coaster variety of returns. It is a long term investment. Costs tend to be less than the small-cap variety.

    Why should you care? It is critical that you understand what investments are available, what you should consider owning, and why you should own them.

    It is wise to own a large-cap index fund and a small-cap index fund when investing in stocks. You can do this separately or all in one fund such as the Total Stock Market Index Fund at Vanguard.

    Why? You want to capture the market return at the lowest possible cost. These two types of funds help you do just that. Research by Fama and French tells us small and value companies have faired better in the past. Will they in the future? We don’t know, but tilting your portfolio slightly in that direction seems prudent (I do it with my portfolio).

    Also, one should consider owning an international index fund at some point to capture the returns outside the U.S. Much can be learned by reading further on this subject. The Four Pillars of Investing is a wonderful book that will enlighten and educate on the topic of investing and the markets. Knowledge is POWER!!!!

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