When Is the Best Time to Invest in Small-Cap Stocks?

Investing in small-cap stocks can be a very smart move for the long-term investor. To optimize their returns, the investor has to know when to buy them. Some people are wise and avoid market timing. However, there are tactical and strategic moves that they can make to change the fund allocation in small-cap stocks when the opportunity presents itself.

There are investors that select an appropriate mutual fund allocation for small-cap stocks and stick to it for the entire period. Occasionally, they rebalance the portfolio; maybe quarterly or annually. Nonetheless, active investors can, in smart ways, alter the exposure of small-cap stock funds for the purpose of improving performance in the long-term. 

Best Economic Environment for Investing

In rising rate environments, small-cap stocks in the U.S have outperformed the large-cap stocks—according to history. These rising rates are observed when the Federal Reserve is no longer reducing interest rates to facilitate the economy or when an economy is starting to recover.

Another time when you should consider buying small-cap stocks is when the market appears to have been down for quite some time. That is, when the market is at a low point and there is not much optimism about it.

It will not be easy to guess this one correctly but when there is extreme pessimism you can easily feel it and see it on the international and local media. 

Why and When Small-Cap Stocks Can Beat Large-Cap Stocks

In a growing economy, smaller companies have the potential to rebound faster than the larger ones. Their general fate is not directly tied to economic factors such as interest rates to facilitate their growth. Small companies are like small boats in the water, they can navigate better and move faster than the huge ocean liners. 

With smaller companies, decisions on new services and products are also implemented faster because their potential obstructions, layers of management and committees are fewer. Large companies do not have this advantage.

When the economy is emerging from recession and experiencing growth, small-cap stocks are able to respond quicker to this new positive environment and even grow at a faster rate than the large-cap stocks.

Small companies usually raise their capital by selling shares. Large companies, on the other hand, do so by issuing bonds. Because small companies are not really that dependent on bonds when funding projects and expanding operations, high interest rates do not negatively affect their ability to grow.

A Brief History

In the years following the 2003 and 2009 recessions, results were mixed. 

In 2003, small-cap stocks led mid-cap stock and large-cap stocks. In 2009, the results were different as mid-cap stocks led and small-cap stocks barely won over large-cap stocks.

Be Cautions with Small-Cap Stock Timing

Your takeaway here should be that averages or rules of thumb do not apply all the time. Even after reading an article about the benefits of small-cap stocks, consider where the information has been sourced from.