Many investors focus only on large-cap stocks. But by looking more closely at small and mid-sized companies, you can often get better returns without a huge increase in overall risk.
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What mid-cap stocks are
Stocks are often divided into three categories based on their size: small-cap, mid-cap and large-cap stocks. Although small-cap and large-cap stocks often receive more attention than mid-cap stocks, they are an important component of a properly diversified financial portfolio.
Mid-cap stocks are generally defined as having a capitalization of between $2 billion and $10 billion, Investopedia asserts. Mid-cap stocks account for approximately 24 percent of the stocks in the Wilshire 5000 Index, which is made up of privately traded stocks in the United States. In contrast, a small-cap stock has a capitalization of $50 million to $2 billion, and a large-cap stock has a capitalization of between $10 billion and $200 billion.
One of the most common factors in a stock's performance is its volatility, which measures its risk. Stocks with higher volatility come with higher risk, whereas those with low volatility are usually stable and low-risk. Although specific performance varies from company to company, mid-cap stocks generally have a higher volatility than large-cap stocks, but less volatility than small-cap stocks. For example, according to the book "Market Evolution" by Jeffrey Kleintop, mid-cap stocks tend to have about 10% higher volatility than large-cap stocks over the course of one business cycle, whereas small-cap stocks have 25% more volatility.
Not only are mid-cap stocks less volatile than small-cap stocks, but they also tend to generate higher returns. Mid-cap stocks have high potential for growth, and often, mid-caps will graduate to large-cap status in time, giving investors substantial windfalls. Mid-cap stock companies also respond faster to changes and innovations in the market because they tend to be more specialized and focused on their own niche.
Knowing the capitalization of a given stock is important not only for those investing directly in individual stocks, but also for investors who use mutual funds. If you do invest in mutual funds, educate yourself about the capitalization of each stock in the fund in order to determine its volatility and return. Regardless of the type of stock or fund you choose, remember that capitalization can change rapidly, particularly with mid-cap stocks. Some mid-cap stocks may be well on the way to becoming industry leaders.
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The article What a Mid-Cap Stock Is (And Why You Should Care) originally appeared on Fool.com.
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