When it comes to investing, small — as in small-cap stocks — beats large. When it comes to returns, these minuscule engines of growth have been kicking the pants off of their larger twins for decades.
Just checkout the work from Eugene Fama and Kenneth French. The duo found that from 1926 to 2012, small-cap stocks managed to outperform large-caps by a cumulative extra return of 253%. That’s an extra 253%.
While large-caps are currently having their day in the sun, small-cap stocks and their growth potential are still worth owning. And many analysts anticipate that the shift back to small-cap dominance will happen sooner than later.
For investors, that means owning small-caps are a must. And the best way to do it, is through small-cap exchange-traded funds. Thanks to their smaller stature, it can be difficult to do proper due diligence on small-cap stocks. With small-cap ETFs, investors get a diverse basket of them with easy, one-ticker access.
But which small-cap ETFs should you buy? The following are three of the best ETFs to buy to take advantage of small-cap stocks.
Small-Cap ETFs to Buy: Vanguard Small-Cap Index Fund (VB)
Expense Ratio: 0.06%, or $6 annually per $10,000 invested
When it comes to a core small-cap ETF, most investors look towards the $35 billion iShares Russell 2000 Index (ETF) (NYSEARCA:IWM). And there is nothing wrong with the IWM. There’s a reason why it’s a favorite among traders and institutional investors.
But odds are, you’re not one of those and the Vanguard Small-Cap Index Fund (NYSEARCA:VB) could be a better choice for us home-gamers.
VB’s index of small-cap stocks is less famous than the Russell 2000, but the CRSP U.S. Small Cap Index still packs a punch. The index covers roughly the entire small-cap stock universe — currently at nearly 1,435 stocks. Top holdings include CBOE Holdings Inc (NASDAQ:CBOE) and Diamondback Energy Inc (NASDAQ:FANG). The index is balanced is between “growth” and “value” small-cap stocks. That allows it to profit in all sorts of market environments.
And profit it has. VB has managed to return a 9.14% annual return since its inception in 2004. That’s enough to turn $100,000 into more than $212,000.
Aside from that great return, the reason to choose VB over IWM is cost. As a vanguard small-cap ETF, VB is basically free to own. Expenses run at just 0.06% or $6 per $10,000 invested. The IWM is more than triple that.
In the end, VB makes for a great core small-cap ETF. It has the low expenses, diversification and returns to help power your portfolio.
Small-Cap ETFs to Buy: SPDR S&P International Small Cap (ETF) (GWX)
Expense Ratio: 0.40%
The small-cap premium doesn’t just stop at the U.S. borders. There’s a whole world of smaller firms internationally that most investors completely ignore. That’s a real shame.
But don’t hold your head and cry, buy the SPDR S&P International Small Cap (ETF) (NYSEARCA:GWX) instead.
The ETFs underlying index — the S&P Developed Ex-U.S. Under USD$2 Billion Index — is a mouthful. But it’s also a measure that tracks stocks located outside the United States with market caps under $2 billion. With it, investors get exposure to small-cap stocks from locales such as Japan, the U.K. and Germany. A total of 2,268 different international small-cap stocks.
With such a huge swath of stocks and its intentional focus, GWX fills a very important and under-utilized niche for investors and it is a perfect example of what ETFs are really for.
As for returns, GWX has been mixed. The recession and shift towards U.S. and dollar denominated assets, caused returns to be lacking. However, the last few years have been better. Over the last five years, GWX has returned 11.23% annually. That’s more of a repeat of what it did before the recession. And with investors shifting back to international equities, GWX could keep the returns going.
Small-Cap ETFs to Buy: PowerShares S&P SmallCap High Dividend Low Volatility Portfolio (XSHD)
Expense Ratio: 0.30%
Another majorly ignored area is small-cap stocks that pay dividends. Believe it or not, there are plenty quality small-cap stocks that pay decent dividends.
The problem is many get swept up in the overall volatility of small-caps. But PowerShares has a solution for let’s say, retirement investors looking to expand their income options.
The PowerShares S&P SmallCap High Dividend Low Volatility Portfolio (BATS:XSHD) is considered a smart-beta ETF and as such, it uses screens to build its portfolio. In this case, it screens the S&P SmallCap 600 Index for those stocks that have high dividend yields as well as exhibited low volatility over the past 12 months. Investors are basically getting stocks with great yields that don’t bounce around as much as other small-cap stocks.
This could be a godsend for those investors looking to exploit small-caps’ dividend paying and dividend growth capabilities. But it also adds a bit of a safety net since, stocks in XSHD won’t move as much.
Investors can have their cake and eat it too.
So far, the cake hasn’t been frosted yet. XSHD debuted right when growth took off at the end of last year. So it has underperformed. However, this is about portfolio insurance and when the market does hit a snag — as it always does — XSHD should do well. Expenses for the ETF run 0.30%. And XSHD pays a handsome 4.47% dividend.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.