Whether you are nearing the end of yourretirement savings process or are just headingfor the starting line, understandingdiversification and the equity investments available toyou is vital. Small, mid, and large cap stocks all haveindividual benefits. But which one is right for you?
One size usually doesn't fit all, and especially notwhen it comes to the stock market. Choosing the rightsized company or fund can be a tricky prospect. "Howare the different levels defined?" and "What are thepros and cons of each type?" are two major questionsmany physician-investors have. When dealing withmarket capitalization and deciding which size is right,it can be a tough choice, so here's an overview of allthree major categories of market capitalization.
Small cap stocks are companies that typically havea small market capitalization, usually somewherebetween $300 million and $2 billion, but definitionsvary. Market capitalization, simply put, is the price ofthe company's stock, multiplied by the number ofshares outstanding. It's basically the value the marketplaces on a company.
With the potential for growth, comes the potentialfor risk as well. All portfolios should be properly diversifiedto help reduce overall portfolio risk. Investing insmall cap stocks comes with an additional set of risksunique to these types of investments; consequently,any money you invest in small caps should be moneyyou're prepared to expose to these risks. Small capstocks are also more difficult to research and chooseprecisely because of their obscurity.
The definition of a mid cap varies greatly dependingupon who you ask. Some define mid caps as companieswith a market capitalization between $1.5billion and $5 billion. Others bump that number upa bit and define them as being between $2 billionand $10 billion. In the end, it depends on exactlywho you ask. Mid caps are generally thought of as ahappy medium between the growth of a small capand some of the stability of a large cap.
Large caps also vary in range, depending on who'sdefining them. In many cases, large caps (ie, blue chipstocks) are stocks with a market capitalizationbetween $8 billion and $200 billion. This rangeincludes some of the giants. With large cap companies,you get more proven stability and less volatility.But in many cases, that means less glamorous returnsand a smaller chance for growth.
As with the other two levels of capitalization, it'snot one-size-fits-all as well. Some investors want theproven reliability of the big names, especially whenthey are nearing retirement. Others value the largecaps because they've already experienced their growingpains and are now established. Many large capcompanies also do a great deal of work around theworld, which means an added flavor of global diversification.Numerous developing countries are seeingthe birth of a middle class (eg, China, Brazil, etc), andmany large US companies are seizing the opportunityand expanding their reach.
Each type of market capitalization category comeswith its own unique risks and rewards. Trying to balancethe risks and rewards of all of the assets in yourportfolio can be tricky. Consulting with a financialprofessional can help you identify which investmentsmay be appropriate for your situation.
Robert Valentine, CSA, of Huntington Beach, Calif, is with
Financial and Retirement Management, a registered investment
advisory firm. He is a registered representative of and offers
securities through Securities America, Inc, and is a registered
broker/dealer, member NASD/SIPC. He welcomes questions or
comments at 877-732-2637.