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Small Cap, Mid Cap, Or Large? What is The Right Mix For Your Portfolio?

Money & Finance

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Before understanding the different types of mutual funds and ETFs, you need to understand market cap. Market capitalization is a quick way of determining how large a company is.
To calculate market cap, take the share price and multiply it by the number of shares outstanding (meaning shares that anyone can buy). This will give you a dollar amount, which is the company’s market cap.
Here are the most common names you’ll see, as well as their corresponding market caps:

  • Large cap – $10-$100 billion
  • Mid cap – $2-$10 billion
  • Small cap – $250 million-$2 billion

For example, let’s say Company A has a stock price of $10 and has 1 million shares outstanding. Their market cap would be:

  • $10 x 100,000,000 shares = $1,000,000,000

So Company A has a market cap of $1 billion. According to the list above, this would make them a small-cap company.
Mutual funds and ETFs will often categorize themselves by the size of companies that they invest in. For example, a large-cap ETF will hold stock in only large-cap companies.
There are a few other types of market caps you may see, but not as often.

They are: mega cap (> $100 billion), micro cap (< $250 million), and nano cap (usually <$50 million).

Ideal asset allocation (and how to choose)

One thing to consider is your own personal level of risk tolerance. Everyone’s asset allocation for stocks is going to be different based on the level of risk that they’re willing to take on.

Here is the mix that I am currently investing with equities:

Ticker ETF Name Indicative
Value
Ticker
Equal Weight
30% RSP Guggenheim S&P 500® Equal Weight ETF RSP.IV
     
10% EWEM Guggenheim MSCI Emerging Markets Equal Country Weight ETF EWEM.IV
30% EWMC Guggenheim S&P MidCap 400® Equal Weight ETF EWMC.IV
30% EWSC Guggenheim S&P SmallCap 600® Equal Weight ETF EWSC.IV

 

It’s important to know the difference between ETFs and mutual funds, as well as their strategies, before investing. Also, understanding market capitalization is crucial before choosing your own investment strategy.
You will also want to make sure you’re comfortable with your asset allocation so you’re not too heavily weighted in one asset class. This will help you keep a well-balanced and diversified portfolio.

 



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Just a quick update to the above article.

I have since moved to holding ONLY RSP Equal Weighted S&P 500 index ETF.

Screen Shot 2017-12-23 at 2.39.41 PM.png

Screen Shot 2017-12-23 at 2.39.50 PM.png

I figure this gives me more than enough exposure globally while ensuring that I'm in the larger boats should the tsunami drain soon.

I would be interested to know how badly hurt this index will be compared to Cap Weighted indexes when the Federal Reserve actually begins to dump their holdings.

What do you want to bet that they didn't invest their QE funds "equally weighted"?

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More about Equal Weighted index effectiveness:

Academics often address this question by calculating the effective number of stocks in a portfolio, based on the Herfindahl Index’s2 measure of concentration. The effective number of stocks equates a particular index’s concentration to that of an equal weighted index. For example, the S&P 500, despite holding 500 companies, has an effective number of stocks of 1423. This means that the S&P 500 has the same level of concentration as an equal weighted index with 142 components. Therefore according to this measure the diversification, 358 stocks, or over 70% of the index, are wasted due to the top heavy weighting scheme.

In addition to the concentration issues related to cap-weighted indexes, there is a potential performance setback as well: market cap weighted indexes inherently provide more exposure to large cap companies and growth stocks, since these companies tend to have higher market capitalizations than small caps or value companies. Fama and French, in their seminal factor research, however, showed that small caps and value companies tend to outperform large caps and growth companies. Therefore constructing an index that has better diversification characteristics not only holds the potential to reduce concentration risks, but also improve performance by moving away from the concentrated large cap growth names in a market cap weighted benchmark. The S&P 500 Equal Weight Index demonstrates this effect: by equal-weighting its components it takes a simple approach of de-concentration and shifts its exposures away from the large cap growth names that dominate the regular market cap-weighted S&P 500 index. Since 2006, the equal weight index has outperformed the regular S&P 500 by an annualized 112 basis points, largely attributable to the inherent size and value tilt of the index4.

https://www.globalxfunds.com/why-your-index-may-not-be-diversified/

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Depending upon the reference index used and the time periods examined, an equally weighted portfolio of U.S. large cap stocks has outperformed its market capitalization counterpart by two percent per year. Similar results have been observed in international markets as well. The MSCI EAFE Equal Weighted Index and the MSCI Emerging Markets Equal Weighted Index have produced greater performance and higher Sharpe ratios than their cap weighted benchmarks over the past 10 years.

...

 

Here is why: in order to maintain equal weights to portfolio constituents, the index must rebalance at a regular frequency. This means that the equally weighted index will sell stocks that have recently appreciated, while purchasing shares that have fallen. Put another way, the equally weighted index systematically buys low and sells high, a good practice for long-term investors. The largest constituents tend to be those who have seen their valuations expand in recent years. Equally weighted indexes have consistent tilts towards smaller, cheaper companies. These types of companies tend to have higher absolute returns than their larger, more expensive counterparts.

Before dedicating a sizeable portion of your portfolio to an equally weighted index, it is important to understand the risks inherent in the strategy. First, the larger exposure to small, undervalued companies has historically meant greater exposure to market downturns. For example, the S&P 500 Equal Weight Index underperformed the market cap version by nearly three percent in 2008 (which itself was down 37 percent that year). Therefore, it might be appropriate to pair this with a less risky investment strategy, like a low beta index (such as the Russell 1000 Low Beta Equal Weight Index). In addition, the very act of rebalancing will generate capital gains, an important consideration for tax sensitive investors to keep in mind. It is best to gain exposure to the equal weight strategies through an exchange traded fund, because the creation and redemption mechanism built into those vehicles can help reduce gains.

https://www.forbes.com/sites/toddmillay/2017/03/06/a-better-way-to-invest-in-index-funds/#5df26847bb69

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