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Small-cap investments: Nimbler, more volatile

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Stocks of smaller companies tend do well at the beginning of economic expansions, but they also can be a bit riskier, Brian Kilb explains in a Money Talk Video interview with Joel Dresang. Here is a transcript of the video.

Joel Dresang: Brian, when you’re talking with investors about diversifying the stock side of their investment portfolio, size matters, right? You talk about small-cap, mid-cap, large-cap stocks. What about small-caps? Let’s drill down on that. What are some of their advantages for investors?

Brian Kilb: The thing about smaller companies is by nature, they’re more nimble and more able to adapt to changing economic conditions. So you’ll often get the fast growers, the newest and the best, the innovators, the creative sorts that may emerge quickly. And sometimes that can be a pretty fun rocket ride.

The downside, however, is that oftentimes they aren’t as resilient to negative economic or market conditions.

Joel: So is it fair to say there’s greater volatility in small-cap stocks?

Brian: Absolutely.

Joel: Does the greater volatility in small-cap stocks mean that the retirement portfolios would be less likely to have big chunks of small-caps?

Brian: Yeah. If you take the long-term perspective, eliminating a very good period for small-caps, 1975 to 1981, there really isn’t a large difference between performance long-term. So you really have to ask yourself in the long run if you want to put up with the headache of a little more risk when it’s not worth the reward over a long period of time.

Now having said that, there are market conditions that favor small caps. And that may be a time when you might add to your portfolio.

Joel: So here we are in the second quarter of 2014. Is this, in the business cycle, a good time or a bad time for small-caps?

Brian: Well, I think two things you want to pay particular attention to are where are we in the business cycle and where are we from a valuation standpoint?

In regards to point number one, we’re 58 months into the current expansion – not in the beginning. And the beginning is what favors small caps, so …

Joel: What about valuations?

Brian: Well, in terms of valuations, if you go back to relative valuations, the small-cap value, small-midcap value asset categories are much more expensive than they have been historically. Large-cap growth is still a little bit cheaper. So, in terms of relative valuations, you’d want to favor large-cap growth over the small caps right now.

Joel: And, again, we’re not talking about an either-or. You want to always have some small caps in your portfolio.

Brian: No, absolutely. And it’s always a function of in the long run, what allocation suits you as an investor.

Joel: It’s everything in balance.

Brian: Everything in balance.

Brian Kilb is executive vice president and chief operating officer of Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May 
(initially posted May 14, 2014)

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