When the economy lags, small-company stocks do, too. Small companies are less likely than their bigger brethren to withstand declining sales. Their businesses are likely to be less diversified, and their balance sheets are usually weaker, too. Plus, investors assume that famous or gigantic companies are safer.
It thus stands to reason that when the market turns -- well ahead of the economy, don't forget -- small-company stocks will snap back more forcefully. Bentley Offutt, an independent stock analyst in Baltimore, says small companies typically have far fewer shares outstanding, and that leads to exaggerated price swings, both up and down.
With thousands to choose from, though, it's tough to point your finger at particular small-company stocks. Two mutual funds to consider are Vanguard Small-Cap Growth Index (symbol VISGX) and Wasatch Small Cap Growth (WAAEX). They complement one another, with little portfolio overlap and holdings in almost every kind of industry.
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The Vanguard offering tracks the MSCI Small-Cap Growth Index of more than 900 stocks, including a slug of consumer, energy and technology stocks but few financials. The fund, with annual fees of 0.22%, returned an annualized 14.5% over the past five years to June 9.
Jeff Cardon has run the Wasatch fund well since 1986. He looks for companies that he thinks can generate earnings growth of 15% annually for at least five years, then patiently holds on to them. The fund, which reopened to new investors in March after being closed for seven years, returned 8% annualized over the past five years and 11% over the past ten. Its annual expense ratio is 1.19%, reasonable for this kind of fund.
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