A:

The best small-cap index funds are the iShares Russell 2000 ETF (IWM), SPDR S&P 600 Small Cap ETF (SLY), Vanguard Russell 2000 ETF (VTWO) and Vanguard Small Cap Index Fund (VB). These funds are rated highly by U.S. News & World Report in terms of liquidity, costs and diversification.

The most tracked and traded small-cap exchange-traded fund, or ETF, is IWM. Many investors prefer watching small-cap funds to more mainstream indexes such as the S&P 500 or Dow Jones Industrial Average (DJIA), feeling they are a better representation of the economy and overall stock market. This is because small caps are more sensitive to economic growth and are domestically focused.

Small caps are unique in that they are highly leveraged to the economy. These companies have smaller balance sheets and are more exposed to the economic cycle. During recessions, many may go bankrupt. This is in contrast to mid- and large-cap companies that have more established operations and reserves to get through and thrive during turbulent times.

For these reasons, small caps are considered a leading indicator for the economy. When traders become enthused about prospects for economic growth, they move into small caps. When they are worried about a slowdown, they start to sell small caps first.

Large-cap companies tend to do business all over the world. More than half of revenues of the S&P 500 come from abroad. In contrast, more than 90% of revenue for small caps comes domestically. Therefore, periods of relative outperformance of small caps to large caps is meaningful in implying domestic economic strength.

RELATED FAQS
  1. Are small cap companies more risky investments than large cap companies?

    Typically, small cap companies are not a safer investment than large cap companies. Read Answer >>
  2. Is there such a thing as a nano cap or micro cap index?

    While there are indexes that track micro cap stocks, there are few indexes tracking nano caps. Although definitions vary, ... Read Answer >>
Related Articles
  1. Investing

    An Introduction To Small Cap Stocks

    When it comes to a company's size, bigger isn't always better for investors. Here is an introduction to small cap stocks.
  2. Investing

    Small Caps: Rising Rates Not All Bad News

    Small-cap stocks can be surprisingly durable in the face of higher interest rates.
  3. Investing

    1Q Small Cap Earnings Preview: The Tide Has Turned

    Earnings growth for small caps should trail large caps badly in the first quarter.
  4. Investing

    A Really Good Deal on Small Caps

    Get paid and get better performance with this small-cap Europe ETF.
  5. Investing

    Why Small Cap Stocks Are Poised for Major Gains

    The Russell 2000 small cap stock index may outperform this year after rising nearly 20% in 2016
  6. Investing

    What's a Small Cap Stock?

    The “cap” in small cap stocks refers to a company’s capitalization as determined by the total market value of its publicly traded shares. Small cap stocks are generally defined as the stock of ...
  7. Investing

    Why Trump's Small Cap Rally Is Flaming Out

    Small caps badly lag the market on concerns about delays in Trump's economic plans
  8. Investing

    Small Caps Are Headed For A Pullback (IWM, VSS)

    The charts of the ETFs that track small-cap stocks look poised for a drop.
  9. Investing

    Sizing Up a Small-Cap Idea

    Small caps are struggling, but remember this ETF for when the group rebounds.
  10. Investing

    Playing Penny Stock-Like ETFs

    While there are no penny stock ETFs or mutual funds, a shrewd investor can pick from a number of small-cap and micro-cap equity ETFs for a similar effect.
RELATED TERMS
  1. Capped Fund

    A capped fund is a fund with specified maximum limitations included ...
  2. Small Firm Effect

    The small firm effect is a theory that holds that smaller firms, ...
  3. Expense Limit

    An expense limit is a limit placed on the operating expenses ...
  4. Capped Rate

    A capped rate is an interest rate that is allowed to fluctuate, ...
  5. Russell 2000 Index

    The Russell 2000 index measures the performance of approximately ...
  6. S&P 600

    The S&P 600 is an index of small-cap stocks managed by Standard ...
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center