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As interest rates keep moving lower from here, it makes sense to diversify your portfolio beyond the market's biggest and brightest. Undoubtedly, the Magnificent Seven, which have seen their market caps swell in recent years, has been the go-to trade amid the higher-rate environment.
However, of late, some of the seven have run onto some tougher terrain. With growing concerns about the S&P 500 and its overconcentration to the tech heavyweights, many investors may wish to make moves to better diversify their portfolios across market caps.
Indeed, diversification is key for investors who don't want to feel the full pains of the next market correction. Though many investors have already made the effort to ensure their portfolios are diversified across sectors, industries, and even geographies, I believe that some investors still haven't yet diversified across market cap sizes.
Sure, large-cap stocks can be a less choppy way to ride the markets higher. Given the often choppier ride that small- and mid-cap stocks entail and the relative lack of performance in recent years, it can feel tempting to stick with the mega-cap heavyweights while neglecting the smaller, up-and-coming names that may very well lead the next growth charge.
Although spreading some chips beyond the blue-chip names and into the smaller-cap stocks can lead to greater volatility without a shot at greater gains, I do think that a subtle rotation makes sense if you're looking to play a lower-rate world ahead of the pack or you're getting a tad uncomfortable with your weighting in mega-cap technology stocks.
Key Points About This Article - Small-cap stocks could be worth owning as rates fall off and the economy stays robust.
- The IWM ETF stands out as a great way to diversify into the small-cap universe.
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Small-cap stocks: Lower rates and a no-landing scenario bode well for them.
As rates fall off as the Fed looks to cut further in the next year or two, investors looking to diversify beyond the top-heavy S&P 500 may wish to do so before the often-neglected smaller-cap names have a chance to shine again. Indeed, the small- and mid-cap wave rose sharply on three separate occasions in the past three months.
The Russell 2000, an index that tracks 2,000 smaller-cap firms, spiked higher on three separate occasions. Indeed, the first one, which happened in early July, saw the Russell 2000 index soar more than 11% before the gains were given back in late August. Shortly after, the small-cap index surged again through most of August, only to fold at the start of September.
The wild ride for the small-cap stocks may not be over quite yet. That said, if you're light on the small-cap stocks, have the desire to diversify away from the mega- and large-caps, foresee much lower rates in 2025, and don't want to be caught watching the next small-cap wave from the sidelines, scooping up a Russell 2000 exchange-traded fund (ETF) makes a lot of sense right here.
The iShares Russell 2000 ETF is a great choice for those seeking instant small-cap exposure.
Indeed, the iShares Russell 2000 ETF ( NYSEARCA:IWM ) makes it incredibly easy to gain exposure to the small-cap scene. For many investors who just don't have the time or know-how to research and pick their own small-cap stocks, the IWM is a go-to option.
The IWM ETF's expense ratio is at a reasonable 0.19%, with a ton (2,000) of holdings, most of which you've probably never heard of. Either way, the IWM is a great choice for young investors seeking a growth edge as we move into a lower-rate environment. As always, though, higher growth tends to accompany greater risks.
The small-cap stocks tend to be incredibly sensitive to rates and the state of the economy. If you're confident that the Fed can pull off that soft landing (perhaps we're already in one) and the economy can thrive as rates head lower, perhaps the small-cap stocks are primed for performance.
Is a small-cap breakout looming?
Recently, Oppenheimer stated that a "rising tide lifts all boats" and that a "small-cap breakout to a new cycle" could be in the cards over the coming months.
Such a breakout would mean big things for the Russel 2000 and the IWM. Either way, I do view the small-cap names as worth diversifying into in this climate if your portfolio is light (or lacking) in them. Just fasten your seatbelt and be prepared for wild swings in both directions.
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