Small cap ETF invest in companies who have a market capitalization of around $250 million to $3 billion with potential for growth but before we jump into the most popular ones, we want to breifly go over what market cap and ETFs are.
What is market cap?
The term market capitalization, or market cap, refers to the most recent market value of a company’s outstanding shares.
Market cap is calculated by multiplying the current price of a company’s stock by the number of shares outstanding. For example, if a company has 10 million shares outstanding priced at $30 each, its market cap is $300 million.
Read on to know what is a small-cap ETF, the qualities you ought to look for in a small-cap ETF, and the most popular small-cap ETFs.
What is a small cap ETF?
The term small-cap refers to stocks with a small market capitalization, between $250 million and $3 billion. Small-cap stocks tend to have substantial potential for growth than large-cap stocks.
In addition, small-caps stocks tend to outperform their large-cap counterparts when the Federal Reserve slashes interest rates.
However, investing in small-cap stocks involves greater volatility and comes with its share of risks. But investors can avoid some of those risks by using small-cap exchange-traded-funds (ETFs).
An ETF is a pooled collection of investments such as stocks, commodities, or bonds that can be bought or sold through a brokerage firm on major stock markets like the Nasdaq and the NYSE. ETFs began trading in 1992 and have gained popularity in recent years as their numbers keep rising.
Small-cap ETFs invest in the stocks of companies with a market cap of roughly $250 million to $3 billion.
What to look for in small cap ETFs
- Low expense ratios
Expense ratio is one of the most important things you should consider when choosing an ETF. It is basically the fee that an ETF charges its shareholders to cover its total annual operating expenses.
Expense ratio is expressed as a percentage of an ETFs average net assets and can include various operational costs like administrative, distribution, compliance, record-keeping, management, investor services, and marketing fees.
For an actively managed portfolio, an expense ratio of around 0.5% to 0.75% is generally considered low, while an expense ratio above 1.5% is regarded as high.
Finding an ETF with a low expense ratio is important, because picking a fund with a higher expense ratio could weigh on your returns. The less you pay, the better your return will be.
- Ample liquidity
Does your ETF have ample liquidity? A small-cap ETF should have enough liquidity in order to make it easy for investors to trade stocks. Simply put, you need to choose an ETF that has enough trading volumes on stock markets during the day.
ETFs with a huge investor base generally tend to have higher liquidity on stock exchanges. At the same time, the underlying stocks that an ETF owns ought to have ample liquidity to enable it to effectively invest in those stocks without higher cost of buying them.
- Diversification from major indices
In world of investing, the term diversification refers to the process of spreading capital in a way that minimizes exposure to risk.
When deciding which ETF best meets your needs, one of the things that you ought to consider is how its diversified from major indices. A good ETF should have hundreds if not thousands of securities in order to protect investors in case of a market crash.
3 best small-cap ETFs for investors
Best overall: Schwab U.S. (SCHA)
The Schwab U.S. Small-Cap ETF (SCHA) tracks the performance of the Dow Jones U.S. Small-Cap Total Stock Market Index. It was introduced to the market on Nov. 3, 2009 and is among the best small-cap ETFs for investors.
The Dow Jones U.S. Small-Cap Total Stock Market Index is a float-adjusted market cap weighted index and includes publicly traded companies ranked between 751 and 2500 by full market cap.
Among the most popular stocks in the ETF’s portfolio include Nektar Therapeutics (NASDAQ: NKTR), GrubHub Inc. (NYSE: GRUB) and GoDaddy Inc. (NYSE: GDDY).
SCHA has a lower expense ratio and a well-diversified portfolio compared with most of its peers.
- 05% expense ratio
- Holds 1,750 stocks in its portfolio
- Trades over 500,000 shares traded per day on average
- $8.4 billion in assets under management
Best for Active Traders: iShares Core S&P (IJR)
Launched in 2000, the iShares Core S&P Small-Cap ETF attempts to track the performance of the S&P Small Cap 600 Index. This fund invests primarily in small-cap stocks that trade with ample liquidity, thus making it ideal for active traders.
HealthEquity, Inc. (NASDAQ: HQY), Neogen Corp (NASDAQ: NEOG), and Stamps.com Inc. (NASDAQ: STMP) are among its top holdings.
- 07% expense ratio
- 600 stocks in its portfolio, thus making it quite diversified
- $45 billion asset pool
Best Growth Fund: SPDR S&P 600 (SLYG)
The SPDR S&P 600 Small Cap Growth ETF is one of the most popular exchange-traded-funds among investors looking for rapid growth in small-cap stocks.
This fund covers stocks that exhibit the strongest growth characteristics based on earnings change to price, momentum, and sales growth.
- 15% expense ratio
- Nearly 400,000 shares traded daily
- $2 billion in assets
Small-cap stocks can help smooth out returns and they are a great way to diversify any portfolio. Moreover, they tend to outperform on improving economic fundamentals as they are less vulnerable to global issues such as trade wars.
Each ETF highlighted in this article offers investors an easy way to gain access to small-cap stocks. These ETFs are suitable for a wide range of investors and have delivered solid returns over time. However, it is important to keep in mind that what you choose needs to match your investment goals.