What Is a Small Cap Fund?
A small-cap fund is a mutual fund that invests in the stocks of smaller companies. Small-cap investing provides investors with some opportunities that are different from those of other classes of mutual funds. Owning shares of one or two small-cap funds can add some additional diversification and potential to a portfolio.
Other People Are Reading
-
Identification
-
Stocks are categorized by the market value of the company or market capitalization. Market capitalization or market cap is the share price of the stock times the number of shares outstanding. Large-cap companies like Exxon Mobil and Apple have market caps of hundreds of billions of dollars. Additional capitalization categories are mid-cap, small-cap and micro-cap. Small-cap companies are those with market capitalization of between $300 million and $2 billion.
Function
-
A small-cap mutual fund will own stocks with market capitalization that fits the fund's definition of small cap. The general definition of small cap is not a hard guideline, so each fund will set its own criteria about what qualifies as a small-cap stock for that fund's investment objectives. For example, the Vanguard Small Cap Index Fund has a median market cap of $1.5 billion, and the T. Rowe Price Small Cap Value Fund has an average stock size of $933 million.
-
Potential
-
Small-cap mutual funds offer investors several advantages over funds that own large-cap stocks. Small-cap stocks have periods of time when they significantly outperform large-cap companies. The goal of small-cap investors is to have their small-cap stocks become large-cap stocks, increasing their investment by large multiples of the original investment. Small-cap companies are also not as widely followed by the Wall Street analysts and large investment firms. A small-cap fund manager can find companies that are have not been discovered and there is potential for significant gains.
Considerations
-
There are times when small caps significantly outperform large-cap stocks and funds, and other periods where the large caps give the superior returns. According to John Bogle in his book "Common Sense on Mutual Funds," these periods are measured in years. Small-cap funds will outperform for four to 10 years, then large caps may have the upper hand, or the returns may be relatively equal. A well-diversified investor should own both large-cap and small-cap mutual funds.
Warning
-
Small-cap stocks and the mutual funds that own them are more volatile and prone to sharp market declines. The small-cap-fund investor should be mentally prepared for periods of declining prices, and if he is confident in a fund's long-term prospects, purchase more shares when the prices fall.
-
References
- Photo Credit stock market analysis screenshot image by .shock from Fotolia.com
