Market Cap Investing: Aligning Funds with Your Goals & Risk

Choosing the right market cap for your mutual funds is primarily a matter of understanding your investment goals and risk tolerance. Different market cap stocks have different risk and return profiles. Matching your preferences to the right type of fund increases your likelihood of achieving results in keeping with your expectations. While there are no guarantees, understanding the various characteristics of different market caps is an advisable first step.

What is Market Cap?

A stock’s market capitalization, or market cap, is a measure of the value of all the stock of that company that is in circulation. If you multiply the price of the stock by the number of shares outstanding, you will get the market cap for a given equity issue. Because a stock’s price is always fluctuating, this number changes regularly. The general level defines the size grouping that a stock receives.

The breakdown for large cap stocks is any stock with a market cap over $10 billion-–a special class called mega cap for stocks over $200 billion exists under some distributions. Stocks between $2 billion and $10 billion are considered mid cap stocks, while those under $2 billion are small cap stocks. Again, there is a special category for micro cap stocks for companies whose outstanding shares are valued at less than $300 million. Each of the different market caps have slightly different characteristics.

Large Cap Versus Small Cap

Large cap stocks tend to be the stocks of well-established, mature companies. While they may span various sectors and industries, you can assume that large cap stocks tend to be relatively stable. Large cap stocks are also likely to pay dividends and have consistent payout policies. In addition, large cap stocks tend to be covered by several analysts, so you can assume that they are well researched and well covered by the press. The management of large cap stocks tend to opt for more conservative corporate policies.

Small cap stocks tend to be in smaller, growing companies with more aggressive policies. They tend to be more volatile, offering larger returns when they advance. They also pose greater risks because these companies are more prone to business risk. You will also have greater risk with small cap stocks because when the market is under pressure, investors tend to prefer larger and safer stocks-–this is called a flight to quality.

Mid Caps

Mid cap stocks typically behave as a hybrid between large and small cap stocks. Within the mid cap space, sector is more relevant. If you choose this balance, you should pay added attention to any sector biases. Overall, mid cap stocks can be a nice blend.

Choosing the Right Size

Given the characteristics of each market cap size, if you want a conservative portfolio, you should choose a large cap fund. If you want to chase returns, a small cap may be more appropriate. Overall, you are most likely to build an appropriate investment portfolio by making an allocation to each of these sizes in proportion to your individual risk tolerance.