Soon-to-Be Retirees, Beware: Small-Caps Are Cheap for a Reason
Higher interest rates make debt more expensive for smaller companies, and that could become challenging for them if we head into slower economic times.


We’re well into the new year now, and investors are naturally wondering which investments will prosper in the months ahead. With the Magnificent 7 stocks (that is, Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla) making up the bulk of 2023’s market gains, many are expecting broader participation from the rest of the market.
Small-caps in particular seem overdue to outperform. Their rally at the end of the year might seem to be confirmation of that idea, but even with the year-end push, small-cap stocks are trading at a significant discount.
I know it’s tempting to dive in. But investors should always be aware of risk. That’s particularly true if you’re retired or close to retirement. Simply put, you don’t have much time to make up for mistakes. And getting overly excited about small-caps could be a mistake.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Cheap stocks are often cheap for a reason. That certainly appears to be the case with small-cap stocks today.
Larger companies more likely to have lower rates locked in
For starters, there’s debt. Generally, bigger companies have much less debt maturing in the near future. Over the past few years, the majority of U.S. homeowners locked in low-rate mortgages. They will enjoy the benefits of that decision for years to come. It’s the same with large companies that have locked in long-term debt at favorable rates.
Smaller companies, on the other hand, don’t have the same access to bond markets for raising long-term debt. They generally use bank lines of credit and shorter-term sources of liquidity. That means their debt is being repriced at substantially higher interest rates, which is a headwind to profits.
Average Interest Rate Paid on Debt
Source: Wisdom Tree, FactSet, MSCI, as of 9/30/2023. Excludes financials sector.
As shown in the chart above, the interest cost over the past year for large-cap companies (S&P 500) is notably lower than for small-cap companies in the S&P 600 and Russell 2000. For weaker companies, higher rates could mean the difference between being profitable or in the red, especially in a recession.
Many smaller companies are unprofitable
Speaking of in the red, did you know that 40% of companies in the small-cap Russell 2000 index are unprofitable today? And that’s with a pretty strong economy. For now. Consumer credit card delinquencies and auto loan defaults are spiking. Bankruptcies are on the rise, as are delinquent commercial real estate loans. These are certainly signs that we may be in for more challenging times, if not an outright recession.
Higher rates plus a slowing economy could mean a spike in bankruptcies in the small-cap universe. But there’s good news: There are some great small-cap stocks out there! Not every small-cap company is drowning in debt, and in some niche areas, smaller companies can be industry leaders. They’re often overlooked — especially in an environment like today when the biggest stocks are getting all the attention.
If you are a roll-up-your-sleeves investor (or have a financial adviser who is), you may be able to find some wonderful businesses at attractive prices. However, if you or your adviser are the type to buy mutual funds and ETFs that own hundreds of positions, be careful. If those funds are broadly invested across the small-cap universe, you may be exposed to a collection of unprofitable and highly levered companies. If we head into slower economic times, what looks cheap today may cost you dearly.
Related Content
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Michael is a Portfolio Manager and Deputy Chief Investment Officer at SAM, a Registered Investment Advisor with the United States Securities and Exchange Commission. File number: 801-107061. He sources investment opportunities and conducts ongoing due diligence across SAM’s portfolios. Michael co-manages SAM’s Income and Tactical Select strategies. Prior to joining SAM, Michael worked with high-net-worth private clients for the largest independent wealth management firm in the United States. He was also a senior analyst for one of the largest investment-grade bond managers in America. Michael joined SAM in 2017.
-
6 Stunning Waterfront Homes for Sale Around the US
From private peninsulas to lakes, bayous and beyond, Kiplinger's "Listed" series brings you another selection of dream homes for sale on the waterfront.
By Charlotte Gorbold Published
-
Six Reasons to Disinherit Someone and How to Do It
Whether you're navigating a second marriage, dealing with an estranged relative or leaving your assets to charity, there are reasons to disinherit someone. Here's how.
By Donna LeValley Published
-
Should You Still Wait Until 70 to Claim Social Security?
Delaying Social Security until age 70 will increase your benefits. But with shortages ahead, and talk of cuts, is there a case for claiming sooner?
By Evan T. Beach, CFP®, AWMA® Published
-
Retirement Planning for Couples: How to Plan to Be So Happy Together
Planning for retirement as a couple is a team sport that takes open communication, thoughtful planning and a solid financial strategy.
By Andrew Rosen, CFP®, CEP Published
-
Market Turmoil: What History Tells Us About Current Volatility
This up-and-down uncertainty is nerve-racking, but a look back at previous downturns shows that the markets are resilient. Here's how to ride out the turmoil.
By Michael Aloi, CFP® Published
-
Could You Retire at 59½? Five Considerations
While some people think they should wait until they're 65 or older to retire, retiring at 59½ could be one of the best decisions for your quality of life.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
Home Insurance: How to Cut Costs Without Losing Coverage
Natural disasters are causing home insurance premiums to soar, but don't risk dropping your coverage completely when there are ways to keep costs down.
By Jared Elson, Investment Adviser Published
-
Markets Roller Coaster: Resist the Urge to Make Big Changes
You could do more harm than good if you react emotionally to volatility. Instead, consider tax-loss harvesting, Roth conversions and how to plan for next time.
By Frank J. Legan Published
-
Why Homeowners Insurance Has Gotten So Very Expensive
The home insurance industry is seeing more frequent and bigger claims because of weather, wildfires and other natural disasters.
By Karl Susman, CPCU, LUTCF, CIC, CSFP, CFS, CPIA, AAI-M, PLCS Published
-
Going Through Probate? How to Find the Right Attorney
Just having the skills and experience to do the job isn't enough. The probate attorney you hire needs to have the right temperament for your particular case.
By John R. Silva, Esq. Published