If you are an investor in the stock market, there is a universe of opportunities. Undoubtedly, you will hear the popular stock market averages mentioned in the press. These include the Dow Industrial Average, Nasdaq and S&P 500. To become truly diversified, you must purchase other assets and in multiple market capitalization classes.
Large, medium and small cap stock
If you’ve heard the term “large cap” or “small cap” stock, it refers to the value the market has given to a particular stock or sector. Stocks are broken down into the following capitalization categories:
1) Large Cap: Stocks valued at 10 billion dollars or more are known as “large caps”. This would include stocks such as General Electric, Caterpillar and Alcoa. The Dow Jones Industrial Average includes the largest 30 stocks in the American stock market. There is a matching ETF (exchange traded fund)whose symbol is DIA. Commonly known as “Diamonds”, this ETF matches the movement of the Dow Jones Industrial Average. Remember the Dow only includes the largest 30 industrial stocks listed on the New York Stock Exchange. If you wanted additional diversity, you could choose a mutual fund or ETF that matched the S&P 500; SPY is the symbol which will closest correspond to the returns of the S&P 500. The symbol SPY is commonly referred to as “Spiders”.
2) Mid Cap: Stocks valued at 1 to 10 billion dollars are known as “mid cap”. Examples of a mid cap stock would be Ross Stores. The closest index matching this asset class would be the S&P 400. You can purchase a mutual fund matching the S& P 400 or the corresponding ETF (MDY)
3) Small Cap: Stocks with a market capitalization of Stocks valued at 300 million to 1 billion dollars are known as small cap stocks. The index matching this asset class would be the S&P 600 or Russell 2000 Small Cap Index. A close matching ETF would be FSLCX
4) Micro cap: Stocks valued from 300 million or lower are known as micro cap stocks. These are considered the smallest and most risky publically traded stocks. Micro cap stocks are also the most illiquid and lightly traded stocks. As with most investments, the higher the risk, the higher the reward. A close matching ETF would be IWC.
Large capitalization stocks are also known as “blue chip stocks” and are usually the industry leaders within their group. They often can offer you foreign exposure as they typically sell worldwide. Since they are behemoth companies, large cap will usually grow slower than small cap. While stocks like General Electric may be The Titanic, a small or micro cap cap stock would be a speedboat.
As always, there are positive and negative factors to both asset classes. While they won’t grow as quick as a small cap stock or index, large cap stocks are more stable (in general) and will sometimes pay a dividend. Small cap stocks reinvest their sales and profits back into their company and thus usually do not pay a dividend. Small cap stocks can also be extremely volatile and may exhibit huge price swings. However over the long term, they outperform large cap stocks by a considerable margin. Why not just invest in small caps and set your portfolio on auto-pilot? Each of these asset classes will exhibit different characteristics depending upon the current market cycle. Small cap stocks will typically outperform large capitalization stocks when the economy emerges from a recession. There will be a period of years or perhaps a decade when large caps outperform small caps. If you properly allocate your investments, you will experience better long term returns than if you invested in a single investment class.
Value versus Growth
Within the universe of small, midcap and large cap stocks, there is the distinction of value and growth stocks.
Growth stocks are shares of fast growing companies that are accelerating rapidly and outpacing the market as a whole. An example of growth stock would be Google. Growth stocks can be high flyers, experiencing huge returns. However, if the stock falls short of earnings expectations or hits an extended setback in sales, their shares can plummet quickly.
Value stocks are often defined as companies that are considered undervalued by investors. If an investor buys a stock or sector they are betting it is “on sale” or cheap. Investors may study an investment and determine that the worst times are behind a particular company and that sales will again accelerate. There is also a possibility another company will buy out a value company who is suffering. Warren Buffet and Benjamin Graham are considered value investors. Long term, value investing has outperformed growth stocks.
Foreign Stocks
With the world in flux and in constant change, you might determine you need exposure in foreign and emerging markets. Investing in international stocks will give your portfolio additional diversification. Over the long term, foreign stocks usually outperform US stocks. However, much like small cap stocks, they can be very volatile. There is less government oversight and regulations overseas. In addition, there are always currency considerations to consider.
How to purchase foreign stocks
There are a number of ways to participate in foreign markets. While it may be difficult to get information or to invest in individual stocks, there are over 2500 mutual funds and ETFs which should be able to satisfy your investment needs. You’ll be buying into a basket of stocks which should get you extra safety as well as professional management.
Foreign investing can be extremely complicated. If investing overseas, you need to ask yourself the following questions:
1) Do you want exposure to a particular country?
2) Do you wish to invest in a region of the world?
3) Do you need the small, mid cap or large cap version of your investment?
4) Are you properly allocated within your foreign investments?
5) Do you want to invest in currency of a country or foreign bonds?
6) What percentage of my overall portfolio should be invested in foreign markets?
Get professional help
If you are overwhelmed, it’s understandable. This is the point where you really have to ask yourself if you want to be an investing by yourself or hire a financial advisor. Your financial advisor will determine your proper allocation and appropriate investments. Your allocation will be based on your financial goal, age and risk tolerance. By investing in mutual funds or ETFs which track an index, you will never be able to beat that specific index because of management fees. However, by being properly invested, you can manage to match or beat the standard benchmark of the S & P 500 which has returned about 9% over a period of 80 years. If you are truly interested in maximizing your returns, do not simply invest all of your money in one asset class.
Investing can be complicated. If you are armed with proper knowledge, you’ll be able to take advantage of the universe of possible investments available to you.
By shorting your portfolio just 2% per year, you will cost yourself tens of thousands if not hundreds of thousands of dollars per year.
Larry Lane is the editor for InvestorZoo.com, a social networking site specializing in personal finance
The article above is information of a general nature and the information provided may not apply to your personal situation. Please consult your financial advisor or licensed professional for investment advice.
Larry Lane is the editor for http://www.InvestorZoo.com a social networking site specializing in personal finance.
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