NBA Has Gone Small: Should Your Portfolio?

Summary

• When I mention investing in small-cap stocks, many clients suddenly have a worried look that crosses their face.
• Maybe it's time to follow the NBA and go small.
• Again, small-cap stocks should be considered for long-term portfolios only, because it's a roller coaster with them, but remember that over the long term, they have produced very nice returns.

As originally appeared in The Jerusalem Post on February 25, 2021.

Whenever I have problems sleeping at night, I inevitably end up watching sports. Since it's basketball season, I have watched my fair share of games recently, in the wee hours of the night.

Ever since the Seattle Supersonics were stolen from the city and moved to Oklahoma City, my interest in the sport has waned some, but recently I actually just don't really enjoy watching the games, as the way the game is played has changed dramatically.

The NBA has embraced 'small ball', which means relying on smaller, more athletic players, who basically get the ball and shoot 3-pointers. It seems like the game has lost much of its strategic element, instead focusing on pure athleticism. Great athletes can produce one-off spectacular plays, but that comes at the expense of fundamentals, and the game in my humble opinion has suffered.

When I watch games with my kids, the biggest "oohs" and "aahs" come when someone's ankles are 'broken'. For the uninitiated, that means when a player on offense performs a dribbling move with the ball, usually a crossover, that causes the defender to either lose balance or fall to the court.

Often this happens but the player misses his shot. The kids are going on about how foolish the player who lost his balance looks while I point out that the point is to get the ball in the basket. It may have been an incredible move, but who cares, he missed the shot. Classic example of style over substance.

While basketball has gone small, the investing world has gone in the opposite direction. Little attention has been paid to small-cap stocks as much of the market's focus has been on large companies, like Microsoft (MSFT), Apple (AAPL), Google (GOOG) (GOOGL), and Amazon (AMZN).
These and other mega-large companies have been by far and away the largest contributors as the major market indices climb to record high levels. But as the global economy opens up and economic growth picks up, it may be time to take a look at small-cap stocks.

Brian Scheid of S&P Global Marketplace writes; "Since Pfizer Inc. and BioNTech announced their long-awaited and encouraging coronavirus vaccine results on November 9, 2020, the S&P 600 and the Russell 2000, both small-cap indexes, have climbed by 40.1% and 36.9%, respectively, through February 22. Large-cap indices have also risen, but not nearly as much. The S&P 500, for example, has risen just 10.5% and the NASDAQ Composite Index has risen 13.8% over the same period."

Fear

When I mention investing in small-cap stocks, many clients suddenly have a worried look that crosses their face. They think it's like investing in the wild-west. Who wants some small company if you can invest in Apple? After all, rare is the situation when anyone, myself included, actually recognizes the names of these small companies - so why on earth should anyone invest in them?

The answer to that question lies in historical returns. Obviously, historical returns are no indication of future results but I think we can learn a lot from history. According to data from Mindfullyinvesting.com, from 1972-2020, small-cap stocks had an average annual return of 11.9% vs 10.8% for large-cap stocks. While 1.1% doesn't seem like much, keep in mind that that's an annual number. Compound that over 20 or 30 years and it's a huge amount.

Long-term

Wow. With such great historical returns, small-cap stocks look great. But as usual, there are some risks. These stocks are very volatile. That means that it's an asset that should be included in a portfolio that has a long-term horizon.

Short-term investors are playing with fire if they decide to invest in this asset class. Actually, it's probably even more correct to say that short-term investors should stay out of the stock market altogether but that's a discussion for another column.

Maybe it's time to follow the NBA and go small. Again, small-cap stocks should be considered for long-term portfolios only, because it's a roller coaster with them, but remember that over the long term, they have produced very nice returns.

Of course, past performance is no indication of any future gains. Speak with your financial adviser to see if there is a place in your portfolio for an allocation to small-cap stocks.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.