What are the advantages and disadvantages of investing in small-cap stocks?

I often write on Quora.com, where I am the most viewed writer on financial matters, with over 252.3 million views in recent years.

In the answers below I focused on the following topics:

  • What are the advantages and disadvantages of investing in small-cap stocks? Many people assume that small caps stocks have outperformed but is that the reality?
  • Is becoming a millionaire in three years realistic? If not, how can somebody become a millionaire in a decade or more?
  • What is the best way to approach risk when it comes to investing? Should volatility be considered a good way to measure risk? How can we reduce risks when investing?
  • What is the best way to invest 15,000, and what factors should influence how we invest – age, what we want to achieve or something else?

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What are the advantages and disadvantages of investing in small-cap stocks?

It can make sense to own large, medium and small cap stocks.

Small-caps have beaten large caps over the ultra long-term, but some periods of time (like the 1930s) seems to have distorted the data.

Yet regardless, smaller companies do add diversification to a portfolio. Take a market like the FTSE250 vs FTSE100 in the UK.

The FTSE250 has regularly beaten the FTSE100 in recent times:

Somebody who has only bought the FTSE100 has only made money in recent times by reinvesting dividends:

The FTSE250 has done well in both capital appreciation and dividends terms.

That is one reason why it can be sensible to own an index like the FTSE All Stars, for UK investors at least, because it includes both investments, alongside the FTSE350 and FTSE small caps.

The same is true in the US. Plenty of people prefer the S&P500 to the Dow, even though they are correlated, as the S&P500 has 500 companies, versus thirty in the Dow.

If you like small caps as well, the total stock market has thousands of shares.

It is one way to become more diversified without always reducing your return. So you can take less risk for a similar return – a win-win.

Small caps are only risky if you buy a few individual stocks in the sector, rather than the index itself.

As a final comment I will say that in recent years small caps have struggled compared to bigger firms, as the pandemic has affected the average smaller company more.

I am sure that won’t always be the case. Historically, small caps have sometimes beaten large caps and vice versa, even though they sometimes move in a correlated fashion.

That can be advantageous.

What are some realistic ways to become self-made millionaire in 3 years?

The only people I know who have become self-made millionaires in just three years have either:

  • Became lucky, like married into wealth. Like inheritance, I don’t think this even qualifies as self-made.
  • Had a job for years. Started their own business and made it big. Yet even though these people seemed to get rich quickly, in reality they didn’t. Even if their bank balances/brokerage accounts seemed to suggest it was a quick process, if you got wealthy quickly after perfecting your craft for years working for somebody else, in reality it was a decade or more in the making. Simple example. If you were selling houses for somebody else and making decent money for a decade, and then make big money after starting your own business, you are only making the big bucks due to the previous experience. This quote sums this up:

In comparison, it is much easier to achieve this over ten years or decade by:

  1. Investing from a young age. If you leverage time, you can get wealthy slowly by investing even small amounts:

2. Take advantage of luck. Most of us get luck, and bad luck. Taking advantage of the good fortune is one of the easier ways to achieve this.

For example, countless people now get 100k-200k inheritances. It is pretty average now. Few invest that inheritance. Imagine two people each received 80k inheritance in 1990.

One person spent it and another invested it into an instrument tracking the stock market. The person who invested it would now have over $1m. If they also added more money, they would be worth less over $1m.

3. Take risks when you are young or don’t have responsibility. Working hard is important. So is working smart. But we can’t outwork everybody in the world.

There will always be somebody who will work harder as they need less sleep than we do. One of the ways to get an advantage is to take more “risks” than other people.

I put risks in inverted commas as many people don’t understand risk. In any case, if you can emigrate when you are young, start your own side hustle or business, get paid on performance rather than by the hour, you will have a better chance of achieving success if you are persistent.

Simple example. If you are a 40-year-old with a mortgage you can’t afford to get a job with a very low base salary but with great bonuses in a few years.

Most 21-year-olds can. What’s more, most people in their 20s can afford to fail at numerous performance-related jobs.

I have lost count of the number of people in their 30s who are making big money, yet spent their early-mid 20s trying to do side hustles, and getting low base salary roles.

Eventually they made it work, and now they are reaping the benefits. Compound probability holds that if you keep taking risks which only have 20% chance of succeeding many times, eventually you will make it work.

How do I approach risk in investing?

How people approach risk in investing differs and there is no 100% perfect answer.

One thing I would say is take as much risk as you want……but make sure you are here tomorrow.

Most people don’t worry about unlikely risks even if the risk involved is being whipped out.

Very few people, for example, worry about seeing their money become worthless in the bank due to interest rates being below inflation, or a currency crisis.

Yet it has made some retirees very poor in numerous countries over the years.

In comparison, if you have your assets in different pots, the portfolio will never go to zero, unless there is a nuclear war or something which would make life itself worthless.

One of the biggest mistakes people make, therefore, is confusing volatility and stability/safety.

Some of the riskiest investments in the world are fixed-return investment which are non-volatile.

Stock markets might be volatile, but they aren’t risky if you hold the entire market long-term.

Nobody has lost money by investing in two or three market indexes for decades as per the stats below:

Yet LOADS of money have lost money directly and indirectly in:

  • Cash
  • Individual stocks rather than the market itself (ETFs or index funds)
  • Professional class investments
  • Property. Just like stocks, the asset class itself might go up, but that doesn’t mean each property does just like each stock doesn’t.

So, if you want the lowest risk possible, you should:

  • Only buy the whole asset class through ETFs – bonds, stocks and REITS. Own everything – the haystack and not the needle.
  • Be ultra long-term
  • Invest monthly or yearly to even out your risk
  • Reinvest dividends
  • Never speculate
  • Never panic when markets are down. Volatility isn’t a problem if you don’t sell.
  • Just ignore the noise, including the news, and invest come rain or shine.
  • Don’t lose heart during those years when markets are stagnant. It is a chance to buy low.
  • Don’t try to time the market.

If you do all of the above, there will be good, bad and so-so years and indeed decades.

Overall, you will do very well, if the last few hundred years is any guide at all.

If the above seems too boring, then do it with 90% of your portfolio, and have 10% in “sexier” things.

As a final comment I would point out that far more people lose money by being afraid of losses than from the losses itself.

Peter Lynch once said that ““Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”

I would add that far more money has been lost from people being worried about investing, and then subsequently regretting it, than people who invest.

What is best way to invest 15K?

It depends on the following factors:

  • Is it the only 15k you have?
  • Do you have an emergency surplus of money in addition to this 15k?
  • Your age
  • What you want to achieve
  • Are you a financial professional or do you have access to advice. I would assume not if you are asking the question.
  • Countless other factors I won’t go into here.
  • Do you have any debt? In which case, paying off the debt often makes more sense, if it is the high-interest rates variety like credit cards.

Assuming you don’t have an emergency surplus, I would keep 3–6 months in cash before investing, unless your job is incredibly secure with sick benefits as well.

Now assuming you have that already, and you don’t have access to advice, I would keep it simple with portfolios like this:

Model portfolios for American citizens and expats under 40 –

60% US Stock Markets,

20% International stock markets,

10% Emerging stock markets

10% US short-term government bonds

Model portfolios for American citizens and expats over 40 –

50% US Stock Markets,

20% International stock markets,

5% Emerging stock markets

25% US government bonds

Model portfolios for American citizens and expats over 55 or close to retirement –

50% US Stock Markets,

20% International stock markets,

30% US government bonds

Model portfolios for British citizens and expats under 40 –

40% UK FTSE All Shares

40% International stock markets,

10% Emerging stock markets

10% Global government bonds index

Model portfolios for British citizens and expats over 40 –

35% UK FTSE All Shares

35% International stock markets,

5% Emerging stock markets

25% Global government bonds index

Model portfolios for British citizens and expats over 55 or close to retirement –

35% UK FTSE All Shares

35% International stock markets,

30% Global government bonds index

Model portfolios for European citizens and expats under 40 –

40% Euro Shares

40% International stock markets,

10% Emerging stock markets

10% Global government bonds index

Model portfolios for European citizens and expats over 40 –

35% European All Shares

35% International stock markets,

5% Emerging stock markets

25% Global government bonds index

Model portfolios for European citizens and expats over 55 or close to retirement –

35% European All Shares

35% International stock markets,

30% Global government bonds index

From the above figures, one can work out what kind of portfolio you should be aiming at, depending on your nationality. If you are from a country which hasn’t got a history of

Or one with REITS as well

10%- Global REIT ETF. Either iShares or Vanguard

55% – Vanguard Total World Stock Market ETF

35% – Vanguard short-term inflation protection securities ETF

Once you have built up more wealth, then you can consider diversifying into other asset classes or getting advice.

Keep it simple to begin with.

Pained by financial indecision? Want to invest with Adam?

Financial Planner - Adam Fayed

Adam is an internationally recognised author on financial matters, with over 252.3 million answers views on Quora.com and a widely sold book on Amazon

Further Reading 

In the answer below, taken from my online Quora.com answers, I spoke about the following issues and topics:

  • What do you do with savings when interest rates are at historical lows, below the rate of inflation?
  • Why isn’t the smartest person in the classroom the most successful one in financial and other terms?
  • Will the dollar collapse in 2021? I suggest why it is foolish to expect such a thing, and even more silly to hope to profit from it. 
  • Is the average investor feeling worried right now, and could that affect stock markets, in a world where institutional investors dominant?

To read more click on the link below.

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