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What are small caps?

Small caps – or small capitalization – refers to smaller-size companies compared to the big, established corporations. But small can be rather big in the financial world. Small caps can mean anywhere from $100 million in market value to typically under $500 million in size. When small cap companies reach the $500-million threshold, many professional managers put them in the category of large capitalization companies.

Small caps can add spice to a portfolio – along with volatility. Historically, the small-cap world tends to be cyclical in nature and a long-term horizon and risk tolerance is particularly important in this category. When the cycle is on the upswing, small cap stocks can reward investors handsomely, but, just as easily, they can prove disappointing. The fact that small-cap investments tend to be more volatile in nature is a reflection of the fact that the companies themselves often have a more narrowly focused product range. Unlike a large, well-established company with a range of products, small cap products usually take longer to generate revenue. As well, small caps rise and fall with the wave of the industry. Economic stability and market trends can boost the business or slow it down. When it comes to small cap investing, keep in mind that there is more risk involved in smaller companies that have yet to grow into larger, established corporations, if indeed they do. Smaller companies don’t have a lengthy track record and often suffer from lack of revenue to bring products to market. Because of the fickle nature of small caps, they are more suited to experienced investors with a high-risk tolerance. For novice investors, mutual funds that invest in small caps offer professional management and a diversified mix of small cap companies to reduce risk and volatility. When it comes to investing in small caps, quality research, risk tolerance, and a longer time horizon is particularly important.