Is It Risky to Buy Small Cap Stocks? 3 Rules for Small Cap Investing

Are you afraid of small cap stocks?

Many investors view small cap stocks as unproven or unstable companies that are too risky to invest in. We think they’re missing out on big profits.

Small cap stocks are not the same as penny stocks or OTC / pink sheet stocks. In fact, investors are often surprised to learn that many famous brands are actually small cap stocks (50 Small Cap Stocks That Are Actually Big Name Brands).

While you can make or lose money investing in ANY type of stock, small caps present a unique opportunity to gain from high profit-potential stocks that are often overlooked by wall street.

So when investors ask if small cap stocks are risky, our bottom line answer is, “They don’t have to be.”

There are a few strategies to reduce your risk when investing in small cap stocks:

Diversify: Please don’t buy just one or two small cap stocks and expect to make money. This is a poor strategy whether you’re investing in small cap stocks, large cap stocks, dividend stocks, growth stocks, really anything. Investors should look to buy at least 10 different stocks in their portfolio, if not closer to 20 or 25 stocks (depending on how much money you’re investing).

And that means diversity within small cap stocks (buying a handful of different stocks), but also diversity across your whole portfolio so you have a good balance of small, large, dividend, blue chip, and growth companies.

Look for High Quality Companies: When investors research large cap stocks or well known blue chip companies, they often look for solid earnings growth, a healthy dividend, smart management, good products, and more. We’d encourage you to look for the same in small cap stocks.

Just because they’re small and less covered than large stocks, doesn’t mean you should just pick some that sound exciting and hope for the best. Apply the same tests you would for any company to see if small cap stocks are worthy of your money.

Do Your Homework: Like all stock market investing, small caps require ongoing homework. They change just as much as large companies, and probably much more. Since they’re small, they’re often more impacted by competitors, customers, suppliers, regulation, legislation, and other factors that could fundamentally change your investment thesis.

Just like large cap stocks, make sure to keep an eye on how the company is performing and don’t be afraid to replace a stock if you find a better alternative.

Small cap stocks don’t have to be scary. Research shows that with the right strategies, they can dramatically outperform large cap stocks.

If you stay diversified, seek out the best companies, and keep doing your homework, you’ll be in a great position to reap big rewards from these small companies.

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