Tuesday, September 14, 2010


That's because small cap stocks tend to outperform coming out of recessions as growth in these nimble operations increases at a greater rate than their larger competitors. While small-cap stocks do tend to have greater volatility (beta) historical returns show that they have done extremely well relative to the rest of the market over the long haul.

According to financial research firm Ibbotson Associates (now part of Morningstar), small-cap stocks have outperformed large-cap stocks over the last 80 years. In a 2005 study, the firm divided the entire stock market into 4 broad categories- small-cap value, large-cap value, small-cap growth, and large-cap growth.

After tallying the results it turns out that if you had invested $1 in large-cap growth stocks in 1927, your investment would have been worth $884 in 2005. That's a great investment, right?

Well, not exactly.

That $884 dollars is pocket change, compared to the $45,144 you would have made if you had invested in small-cap value stocks. This is compounding returns at its absolute best. To some, the difference in annual returns might look insignificant. But over 75 years, the effect of compounding returns and outperformance meant that the same dollar that returned 884% in large-cap value returned over 45,000 percent when invested in small-cap value stocks.

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