Robinhood Stock Trade: Why I Buy Small Cap Value Stocks

Written by Zac Vineyard

A Common Sense Investment Strategy

Last spring I was lucky enough to be an audience member in the Rathbone Warwick Investment Forum and it changed the entire way I viewed my stock portfolio. I went from trying to guess which companies would be a good investment to establishing an investment strategy that had already shown success. It came with a few rules, as outlined by the keynote speaker that day, Weston Wellington, Vice President at Dimensional Fund Advisors.

Wellington really put a number of investment ideas into perspective for me. Here are a few of the key ideas I'm taking to heart:

  • It is impossible to time the market
  • Investors hold shares in over-performing and underperforming companies
  • We must accept market returns
  • Long term investment is more about identifying risk than reward

Here's a quote from the Rathbone Warwick website:

Traditional managers strive to beat the market by taking advantage of pricing “mistakes” and attempting to predict the future. Too often, this proves costly and futile. Predictions go awry and managers miss the strong returns that markets provide by holding the wrong stocks at the wrong time. Meanwhile, market economies thrive because they direct scarce resources to their most effective use.

The futility of speculation is good news for the investor. It means that prices for public securities are fair and that persistent differences in average portfolio returns are explained by differences in average risk. It is certainly possible to outperform markets, but not without accepting increased risk.

When you reject costly speculation and guesswork, investing becomes a matter of identifying the risks that bear compensation and choosing how much of these risks to accept. Financial science identifies the sources of investment returns.

That financial science Wellington refers to is connected to categories of stocks that, over time, hold different levels of risk and reward. The two categories that stuck out to me are these: small-cap value stocks and large cap growth stocks. There two categories are on opposite ends of a spectrum.

Large Cap Growth Stocks

Large cap growth stocks are stock funds that usually have lower risk and lower reward. They have holdings in companies with a market capitalization value of more than $5 billion (often much more than $5B) and usually grow very slowly over time. Companies help by large cap growth funds usually have beta values near 1.0 and follow the market's ups and downs.

Small Cap Value Stocks

Small cap value stocks are stock funds that usually have higher risk and higher reward. They have holdings in companies with a market capitalization less than $5 billion and usually grow at a higher rate over time than large cap growth stocks. Companies held by small cap value funds usually have more volatility and swing higher and lower with the market's ups and downs.

But here's a big takeaway. If you can stomach the risk, "it is certainly possible to outperform markets." If your money can be in the market for a long time, you have better odds of higher returns by investing in small cap value stocks than large cap growth stocks. Trying to time the market it futile. Just invest at a level of risk you're comfortable with, and invest today, even if you think the market is about to take a big nose-dive.

Need a Small Cap Value Fund Recommendation?

If you're looking for a small cap value fund for your portfolio, check out FYT, the First Trust Small Cap Value AlphaDEX Fund ETF.

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