Small-cap stocks are generally companies with market caps between $300 million and $2 billion — which may not seem that small, but when you think about the number of companies worth hundreds of billions (and even trillions), you see why these companies are considered the small players in the stock market.
With a smaller size comes much more room for growth within both a business and its stock price. That's what makes them so potentially lucrative for investors. You won't see many blue-chip stocks doubling their value in one year, but the right small-cap growth stock could provide exponential returns.
After all, the fourth-largest public U.S. company (as of August 16), Amazon (NASDAQ: AMZN), was once a small-cap stock. Needless to say, it's not anymore, and I'm sure a lot of people are retiring early thanks to investing in it throughout the years.
(Here's where I shamelessly mention that The Motley Fool recommended buying Amazon in September 1997, roughly four months after its IPO.)
Bear markets aren't favorable to the small
With small-cap stocks' high upsides comes just as much risk. Since they don't have the resources and bank accounts of larger-cap companies, they're much more susceptible to volatility, and they have a harder time making it through rough economic times.
During bear markets, when the overall stock market is experiencing declines, small-cap stocks tend to get the short end of the stick. The Russell 2000 — considered the benchmark for small-cap stocks (like the S&P 500 for large-cap) — has consistently shown us this.
As of August 16, the Russell 2000 is down over 11.5% YTD, while the S&P 500 is down just over 10%.
During the Great Recession, the Russell 2000 dropped over 46% from September 2008 to March 2009. During the early stages of the COVID-19 pandemic in 2020, it dropped almost 40% from February to March.
The S&P 500 dropped 45% and 30% during those same time periods, respectively.
The tide usually turns
Even though both are down in 2022, since their June 16 lows, the Russell 2000 is up over 21%, while the S&P 500 is up just under 17%.
This points to a larger trend: Small-cap stocks often have more upside than large-cap stocks during the early stages of a bull market. During bull markets, prices usually increase faster than they drop during bear markets because investors rush to put more money into the stock market to take advantage. This increase in investors looking for growth benefits small-cap stocks.
This doesn't mean you should wait for stock prices to bottom out so you can invest in small-cap stocks, because attempting to time the market is a fool's game.
But if small-cap stocks are a part of your portfolio — which they should be if you have a while until retirement — then it does mean that the 2022 struggles shouldn't be too much of a cause for concern. That's especially true if you're investing in broad small-cap index funds, like the Vanguard Russell 2000 ETF (NASDAQ: VTWO), that spread out your risk and ensure you're not relying on too few companies.
There's no guarantee that any company will make it through tough economic times, but you can safely bet that a major index consisting of thousands of companies eventually will.
That's why it's important to invest and focus on the long-term. If you focus too much on short-term happenings in the stock market, it may cause you to make decisions that generally go against your best, long-term interest — such as prematurely selling stocks because prices are falling, or going all-in when prices are rising. Keep your eyes on the prize.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Stefon Walters has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.