Why I Allocate Part of My Portfolio to Small-Caps

As a dividend investor the individual companies I tend to hold are those big well established companies that have been around long enough to afford them the possibility and ability to raise their dividend each and every year. However, good portfolio performance dictates that these stocks do not make up the only part of my portfolio. As you know, I also use various index funds to create the core or foundation of my portfolio.

A part of my asset allocation includes a small-cap component. I do this really for two reasons:

1. To Provide Portfolio Diversification

This reason is pretty self explanatory. By adding in small-caps I am spreading my money around more to take advantage of the markets constant jockeying of returns from one asset class to another. My being in more asset classes I reduce my portfolio’s volatility and risk.

2. To Try to Boost My Returns

Small-cap stocks have been known to provide better returns over time. These lesser-known, lesser-followed companies can grow much quicker than large-cap stocks simply because of economies of scale. This often leads to huge stock price appreciation. Have a look at the following chart to see the various returns of asset classes over time and it is clear that small-caps have been very strong performers.

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Summary

At the end of the day I am trying to make my portfolio bigger. I do that by building an asset allocation that balances risk with reward. I am comfortable taking on more risk to get that additional return that small-caps can provide. However, I do ensure that small-caps are not a disproportionate percentage of my portfolio and I only use index funds to purchase them. I do not have the time nor desire to research and track 100’s of small-caps to find the jewels. Instead, I would rather buy a bunch through an index fund and let the market do the work.

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