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Thursday, December 15, 2011

Are you Investing in Small Cap Stocks?

Should you need to invest in small-cap stocks? The answer is yes, but with some limitations.

First, consider that small-cap stocks have a strong, long-term track record. As a group, small-cap stocks have beat large-cap stocks fairly consistently for a number of years.

Small-cap stocks are generally considered to have a market capitalization of $1 billon or less.
That success alone makes them worth adding to your portfolio.

Smaller companies often have more room to grow and an easier time posting strong numbers. It is much easier for a company with a market cap of Rs. 200 million to double in size than for a company with a market cap of Rs. 200 billion to double.

Small companies are often the innovators and are nimble enough to grab market share when an opportunity arises.

However, when you see the kind of growth numbers successful small companies post, it is easy to forget that small companies live a perilous life.

Large companies can gobble them up or move into their market and over-whelm them. Any number of other factors can stifle growth or wipe small companies out of their market.

Which is another way of saying, smaller companies are often more risky investments than larger companies. With extra risk comes the opportunity for exceptional growth and the opportunity for complete failure.

You should have some small-cap stocks in your portfolio. How many and what type depend on your tolerance for risk. Small companies certainly can and do grow into big companies, however many either vanish or never grow out of the small-cap stage.

Younger investors can often tolerate the risks of investing in small companies better than investors approaching retirement.

Find the right mix of larger and smaller stocks for your risk tolerance and you will be in a good position to take advantage of the growth potential of small companies while not risking everything.