Market capitalization plays a meaningful role in how investors see stocks. Penny stocks are considered some of the riskiest investments on the market, while large-cap stocks are generally more stable. However, there’s a sweet spot in the market cap range where the tradeoff between risk and reward is compelling.
That sweet spot is small-cap stocks.
Small-cap stocks have a history of outperforming larger companies, although they come with more risk than their large-cap counterparts. One of the best ways to offset risk when you invest in small-cap stocks is to invest in exchange-traded funds (ETFs).
Best Small-Cap ETFs
ETFs have become the darlings of the stock market because they’re low-cost, heavy diversification investment vehicles that give you exposure to the assets you’re interested in. ETFs are the way to go if you want to invest in small-cap companies and shield yourself from added volatility.
You own shares of Apple, Amazon, Tesla. Why not Banksy or Andy Warhol? Their works’ value doesn’t rise and fall with the stock market. And they’re a lot cooler than Jeff Bezos.
Get Priority Access
But not all small-cap focused ETFs are the same. Each fund has its own investment objectives and strategy for achieving its goals. They also charge different fees, some of which are enticingly low and others are excessively high.
Moreover, there are several different types of small-cap stocks. Some are domestic, others are international. Some pay dividends, others have strong growth metrics. The apples-to-oranges comparisons can go on forever, but the bottom line is that it’s important to find the best ETFs in any category before making an investment.
Pro tip: David and Tom Gardener are two of the best stock pickers. Their Motley Fool Stock Advisor recommendations have increased 563% compared to just 131.1% for the S&P 500. If you would have invested in Netflix when they first recommended the company, your investment would be up more than 21,000%. Learn more about Motley Fool Stock Advisor.
1. Vanguard Small-Cap Value ETF (VBR)
Best for value investors who want exposure to small-cap companies.
- Performance: The VBR fund has lost about 7% year-to-date (YTD). The ETF is down nearly 5% over the past year and has gained more than 36% over the past five years. The fund is up more than 241% since its inception.
- Expense Ratio: 0.07%.
- Dividend Yield: ~1.83%.
- Morningstar Return Rating: Four stars.
- Allocation: Small-cap stocks in nearly all industries. Stocks in the portfolio have strong value characteristics.
- Assets Under Management: $23.13 billion.
The Vanguard Small-Cap Value ETF is one of the most popular small-cap funds on the market today with more than $23 billion in assets under management. The fund’s goal is to track the returns of the CRSP U.S. Small Cap Value Index as closely as possible before expenses.
The index tracks small-cap companies that are undervalued based on book-to-price, historic earnings-to-price, dividend-to-price, and sales-to-price ratios. This value investment strategy has worked well for VBR since its inception. A $10,000 investment in VBR 10 years ago would be worth nearly $30,000 today.
2. iShares Core S&P Small Cap ETF (IJR)
Best for diversified exposure to U.S. small-cap stocks.
- Performance: The IJR fund has lost over 12% YTD and more than 10% over the past year. The fund has climbed 44.7% over the past five years and is up more than 482% since its inception.
- Expense Ratio: 0.06%.
- Dividend Yield: ~1.69%.
- Morningstar Return Rating:. Four stars.
- Allocation:. U.S. small-cap stocks in nearly all industries.
- Assets Under Management: $62.64 billion.
The iShares Core S&P Small Cap ETF provides diversified exposure to U.S. small-cap stocks. The fund has no specific focus on any core investment strategy like value, growth, or income. Instead, it banks on heavy diversification and broad small-cap exposure.
The IJR uses the S&P SmallCap 600 as a benchmark. The index tracks 600 companies in the small-cap segment of the U.S. market, and following it has proven to be a smart choice for the fund and its investors. If you had invested $10,000 in the fund 10 years ago, the investment would be worth more than $29,000 today.
3. Vanguard Small-Cap Growth ETF (VBK)
Best for small-cap stocks with strong growth metrics.
- Performance: The VBK fund is down more than 23% YTD and more than 22% over the last year. The fund has climbed more than 47% in the past five years and is up 340% since its inception.
- Expenses Ratio: 0.07%.
- Dividend Yield: ~0.39%.
- Morningstar Return Rating: Three stars.
- Allocation: U.S. small-cap stocks with strong growth metrics in nearly all industries.
- Assets Under Management: $12.25 billion.
The Small-Cap Growth ETF is another popular low-cost investment-grade fund from Vanguard. The fund invests in a wide range of U.S. small-cap companies across several industries.
The fund tracks the CRSP US Small-Cap Growth Index, which includes stocks of smaller companies with strong growth characteristics.
When you invest in VBK, you’re investing in a diversified portfolio of stocks that are known for producing growth and that are expected to continue growing over the long term. If you had invested $10,000 in the fund 10 years ago, your investment would be worth more than $27,000 today.
4. Schwab U.S. Small-Cap ETF (SCHA)
Best for complete U.S. small-cap exposure.
- Performance: The SCHA fund is down more than 16% YTD and more than 15% over the past year. The fund has climbed more than 35% in the past five years and more than 245% since its inception.
- Expense Ratio: 0.04%.
- Dividends: ~2.62%.
- Morningstar Return Rating: Three stars.
- Allocation: A broad list of U.S. small-cap stocks.
- Assets Under Management: $13.76 billion.
The Schwab U.S. Small-Cap ETF features one of the most diversified small-cap portfolios among all ETFs in the category. The fund invests in a broad range of industries and has no interest in a single type of investment like growth, value, or income.
The fund tracks the Dow Jones U.S. Small-Cap Total Stock Market Index to make this high-level diversification possible. The index tracks more than 3,600 small-cap companies across the U.S.
Like most other small-cap funds, SCHA has struggled over the past year. However, unlike most, its performance has been impressive since its inception when you flatten out the peaks and valleys. If you had invested $10,000 in the fund 10 years ago, your investment would be worth more than $25,000 today.
5. iShares Russell 2000 ETF (IWM)
Best for Russell 2000 exposure.
- Performance: The IWM fund has lost more than 17% over the past year. The fund has climbed more than 33% over the past five years and more than 263% since its inception.
- Expense Ratio: 0.19%.
- Dividend Yield: ~1.17%
- Morningstar Return Rating: Three stars.
- Allocation: A list of 2,000 U.S. stocks across a broad range of industries.
- Assets Under Management: $51.76 billion.
Addressing the elephant in the room, the iShares Russell 2000 ETF has one of the highest expense ratios on this list. However, at 0.19%, the fees are still well below the industry-wide average.
With that said, the fund is another way to gain diversified exposure to small U.S. companies. That’s especially true if you’re not interested in choosing a single strategy like growth, value, or income.
The Russell 2000 Index is the benchmark that guides the iShares Russell 2000 ETF portfolio.
The index tracks the 2,000 smallest stocks in the Russell 3,000 index, which covers most of the investable U.S. stock market. In other words, the fund invests in the broad U.S. stock market minus the 1,000 largest companies.
The fund’s long-term performance has been impressive, consistently outpacing its peers since its inception. If you had invested $10,000 in IWM when it was launched in 2013, your investment would be worth more than $25,000 today.
6. Invesco S&P Small-Cap Low Volatility ETF (XSLV)
Best for risk-averse investors.
- Performance: The XSLV fund is down more than 10% YTD and just over 1% over the past year. The fund has gained more than 6% over the past five years and more than 84% since its inception.
- Expense Ratio: 0.25%.
- Dividends: 1.31%.
- Morningstar Return Rating: One star.
- Allocation: 120 small-cap stocks characterized by low volatility over the past 12 months.
- Assets Under Management: $955 million.
If you’re a risk-averse investor who wants to tap into small-cap stocks, the Invesco S&P Small-Cap Low Volatility ETF is a great way to do it. The fund isn’t likely to experience any significant growth, like any low-risk fund, but you don’t have to worry about significant drawdowns either. Instead, this ETF invests in stocks that remain relatively stable and produces slow–and-steady growth over long periods.
To do so, the ETF uses the S&P SmallCap 600 Low Volatility Index as a benchmark. This means it invests in the 120 lowest volatility stocks with the highest dividend yields listed on the S&P SmallCap 600 Index.
This slow growth only earned the fund a one- star return rating by Morningstar, but that’s commonplace among low-volatility funds. These funds aren’t built for stellar growth.
Although the fund is great for risk-averse investors, some may be turned off by the slow growth the fund produces. If you had invested $10,000 in the XSLV 10 years ago, your investment would be worth about $18,000 today.
7. iShares MSCI EAFE Small-Cap ETF (SCZ)
Best for international small-cap exposure.
- Performance: The SCZ has fallen more than 15% YTD and more than 18% over the past year. It has gained 4.52% over the past five years and more than 21% since its inception.
- Expense Ratio: 0.39%.
- Dividend Yield: 3.64%.
- Morningstar Return Rating: Three stars.
- Allocation: A highly diversified list of international small-cap stocks.
- Assets Under Management: $11.45 billion.
The iShares MSCI EAFE Small-Cap ETF is another fund with a relatively high expense ratio, but that’s to be expected when investing in an ex-U.S. ETF. The fund invests in international small-cap stocks in developed economies excluding the United States and Canada.
The fund’s performance has been one of the worst on this list from a price appreciation standpoint, but it has produced compelling income. The nearly 4% dividend yield on the fund is in line with many prized blue-chip dividend payers.
However, an investment in the SCZ isn’t for the faint of heart. The fund experiences high levels of volatility that may turn many investors off.
If you had invested $10,000 in the SCZ 10 years ago, your investment would be worth about $17,600 today.
8. ProShares Russell 2000 Dividend Growers ETF (SMDV)
Best for income investors who are interested in small-cap exposure.
- Performance: The SMDV is down more than 7% YTD and has experienced similar declines over the past year. The fund has grown 13.55% in the past five years and more than 50% since its inception.
- Expense Ratio: 0.40%.
- Dividend Yield: 2.33%.
- Morningstar Return Rating: Three stars.
- Allocation: A diversified list of small-cap stocks across various industries that are characterized by growing dividends.
- Assets Under Management: $851 million.
The ProShares Russell 2000 Dividend Growers ETF has a relatively high expense ratio when compared to others on this list, but it’s about in line with the average expense ratio in the ETF industry. Moreover, the portfolio is worth the added expense for some, especially income investors.
The ETF is the only investment-grade fund that exclusively invests in the best dividend growers listed on the Russell 2000. When you invest in the fund, you’re investing in a portfolio of small-cap companies across a wide range of sectors that have consistently increased their dividends for the past 10 years or more.
The fund is like a small-cap version of a dividend aristocrat fund.
However, as a dividend ETF, it’s not the fastest grower. Nonetheless, the low volatility and high dividends make the fund a great investment for retirees and others who depend on income from their investments. If you had invested $10,000 in the SMDV at its inception in 2015, your investment would be worth about $15,000 today.
Final Word
Small-cap ETFs vary wildly in terms of returns, expenses, and portfolio allocation. Always do your research before making an investment in any ETF or other security. Consider the following when you do:
- Investment Objectives. The fund’s investment objectives should align with yours.
- Investment Strategy. Consider how aggressive the strategy is and whether it lines up with your risk tolerance.
- Cost. Most ETFs charge an expense ratio. The lower the ratio, the more of your gains you’ll get to keep.
- Past Performance. Past performance isn’t always an indication of what you can expect in the future, but it’s an effective way to determine how well the fund is managed and whether it will perform well compared to its benchmark.
Disclaimer: The author currently has no positions in any security mentioned herein nor any intention to hold any positions within the next 72 hours. The views expressed are those of the author of the article and not necessarily those of other members of the Money Crashers team or Money Crashers as a whole. This article was written by Joshua Rodriguez, who shared his honest opinion of the securities mentioned. However, this article should not be viewed as a solicitation to purchase shares in any security and should only be used for entertainment and informational purposes. Investors should consult a financial advisor or do their own due diligence before making any investment decision.