There are many small-cap and mid-cap companies in the fund universe, but they only account for a tiny fraction of the total U.S. stock market. By contrast, the S&P 500, a large-cap index, accounts for about 85% of the total capitalization of U.S. stock. But that doesn’t mean picking the best small-cap and mid-cap for your portfolio and life is an easy task.
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Small and mid-cap stocks can be relatively illiquid, highly volatile and vulnerable to changes in the economic cycle. They can also provide critical diversification to long-term portfolios. And the best of the breed, of course, will eventually go on to join the large-cap universe as they grow in size and stature. Small and mid-cap funds are, therefore, an important consideration for investors who are planning for retirement and other long-term goals.
Let’s take a peek at a hypothetical investor to see how small-cap and mid-cap funds play a role in his retirement portfolio.
Case Study: Martin
Martin is in his late 20s, single and employed with a software development company in a major U.S. city. He recently started to invest for his retirement, maxing out his company’s 401(k) plan each year.
Like many employees, Martin doesn’t get much investing advice from the plan sponsor, and researches online to learn how to invest. He’s learned that his current portfolio is very heavily weighted towards large-cap stocks and could benefit from adding some small and mid caps. Martin understands that he’s young enough to tolerate higher volatility in pursuit of long-term growth.
Martin McKenzie’s Top Three Small/Mid Cap Equity Funds
These are from a pool of 1453 funds with a track record of at least 10 years.
Martin is particularly concerned about long-term performance, so he likes the fact that these funds have made big gains, relative to the broad market, for longer time periods. He understands that smaller cap stocks will tend to have higher volatility (as measured by three-year standard deviation) than large blue chips. He notes that the No.1 fund, Homestead, delivers comparable returns for less risk along with a fee structure that is reasonably in line with the peer group. Martin doesn’t believe in paying more than he has to for good performance.
What about poor performers? Here are three funds Martin wants to avoid, for reasons varying from poor returns over time to high fees. Two of the funds also seem to have a higher-than-desirable level of risk while the other (American Century Vista) has a risk level lower than the S&P 500 but lags considerably behind the Vanguard index fund proxy in multi-period returns and in fee structure.
Three Worst Equity Funds for Martin McKenzie
Whether you’re choosing funds for long-term investment goals or allocating a small percentage of your portfolio for intermediate tactical plays, pay close attention to performance in the areas that matter most to you—whether that be long- or short-term returns, risk, management team tenure or fees.
Keep in mind that generic rankings are not going to give you insights into how the fund’s performance relates to your unique investment goals. And watch out for brokers trying to sell you whatever funds their firm happens to be pushing that week.
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