Why would being small ever be good?

Why would anyone be interested in small things? We like big cars, big houses, we as a people and culture like big. So why would there be a reason to invest in small things?

Why is it sometimes good to be small?

Why would someone want “Small-Cap companies” as opposed to “Large-Cap companies”? Large-Cap companies by definition make more money than Small-Cap, and in some cases extremely massively more. So why wouldn’t everyone invest in Large-Cap?

The issue is “Agility”

It may sound weird referring to a company’s agility, instead of an animal or athlete, but agility basically means the ease at which something can move and change directions.

If there is a portfolio that has $1M, and the owner wants to change the direction, or respond to changes in economic indicators, to move 1% of their portfolio they need to sell $10,000 and buy another $10,000.

If however, the portfolio had more, say $100M, to change 1% of the portfolio, now requires selling and buying another $1,000,000. Moving $1,000,000 is harder than moving $10,000. The $100M portfolio will certainly generate a larger income.

If the portfolio had, even more, say $100B, to change 1% now requires $1B, and moving $1B just to change 1% is much more difficult than moving $1M.

That is why being smaller can be better. It can allow the companies, and the mutual funds to react faster to changes in indicators and other data. There are times when open-end funds “close”, and stop issuing new shares. When mutual funds start getting too large, and the manager thinks it is beneficial, they may stop accepting new money into that mutual fund, so it doesn’t grow any larger, and thus slower to steer.

Small companies historically have the highest returns, but they also have the highest risk. If there are 2 portfolios, one with $1M and the other with $1B, and both lose $1M… one of them is a bit worse off than the other. Percentages can make these comparisons a little harder to understand intuitively.

That is why more aggressive, young investors generally will want to be in small cap. They have a long time horizon and could be thought of as more willing to take the mogul course on the stock market sky slopes. They are more willing to bob and weave and move quickly.

That is also why more conservative, older investors, generally are more looking towards the large cap for their equity portion. They have a shorter time horizon, and could be thought of as more willing to do the bunny slopes, slow, steady, not particularly exciting, but also not as likely to fall and break a hip. They are less likely to want to bob and weave, and more likely to want a reasonable steady, straight course.

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