A common way to go about investing for newcomers to the stock market is to invest in large-cap stocks, often representing companies the investor knows well. Many investors avoid penny stocks and small-cap stocks because of their higher volatility and increased risk.
But history tells a completely different story than what many investors believe.
In fact, historically, small-cap equities tend to perform in line with — or even outperform — their large-cap counterparts. Companies trading with market caps ranging from $300 million to $2 billion haven’t completely saturated their markets and have plenty of room to grow.
However, choosing individual stocks in the small-cap space can be a dangerous process that has significant repercussions. As a result, investors find simplicity and safety in diversified small-cap exchange-traded funds (ETFs).
What to Look for in Small-Cap ETFs
As with any other investment, investment-grade funds aren’t all created equal, even those designed to track the same specific sector of the market. Each fund follows its own strategy and comes with its own cost structure.
When looking for the best small-cap funds, there are a few important factors to consider:
First and foremost, you’ll want to consider each fund’s expense ratio, which represents the annual cost to invest in the fund. After all, you’re in the market to make money, not spend it.
Due to the power of compound gains in the stock market, what may seem like a small increase in cost can make a drastic difference in your overall returns over time.
The average ETF expense ratio is 0.44%, according to The Wall Street Journal. Many of the best exchange-traded funds available today are passively managed index funds, which you can expect to cost even less than this.
Historical performance is key. If a fund generated 5% annualized returns over the past 20 years, there would be little reason to expect anything much different this year.
If a fund has generated 15% annualized gains over the past 10 years, you might expect for it to continue outpacing the market, making it a strong investment opportunity.
The vast majority of ETFs have diversification at the center of their strategies, which offers up some protection from risk, but you’ll also want to pay attention to the fund’s asset allocation. While all small-cap funds focus on investment dollars in the small-cap space, different funds do so in different ways.
For example, some funds focus on international investments while others keep their investments domestic. Some funds focus on one small-cap-centric stock market index, while others will focus on other small-cap-centric indexes.
Before investing, take the time to get an understanding of what underlying assets the fund is piling its money into.
There are plenty of companies with small market capitalizations that happily pay dividends to investors when possible, so you’ll want to consider dividend income when choosing a fund to invest in.
Morningstar Return Rating
Morningstar is a financial firm that provides return ratings for various investment vehicles. This is a five-star rating system for ETFs based on their historic performance. The higher the rating, the better you can expect your investments to perform.
Recently, investors have become more concerned with how the companies they invest in work to make a change in the world around them.
The environmental, social, and governance (ESG) score according to ETF.com is a great way to quickly get an understanding of how your investments affect the world around you based on the environmental and social activities of the stocks owned in the portfolio.
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Best Small-Cap ETFs
Here are some of the best ETFs with a small-cap focus to consider if you’re looking to add exposure to relatively small businesses that come with big opportunities.
1. iShares Core S&P Small-Cap ETF (IJR)
iShares is a fund management company that’s been around since 2000 and has collected more than $2 trillion in investment dollars for its funds. One of its best small-cap funds is the iShares Core S&P Small-Cap ETF.
The goal of the fund is to track an S&P index made up of small-cap United States companies. As a core fund, it doesn’t focus particularly on growth, value, or income, but offers a mix of these styles of stocks all in one investment.
The key stats for the fund are as follows:
- Expenses: The IJR fund is passively managed, meaning it costs less to manage it, and those savings are passed down to the investor. The expense ratio is only 0.06%, which is significantly lower than average.
- Historic Performance: The fund is known for outperforming other funds in its category. Over the past one, three, and five years, investors have enjoyed returns of 76.77%, 14.06%, and 15.78%, respectively, while the average performance for the sector was just 3.71%, 4.58%, and 12.14%.
- Portfolio Makeup: The fund focuses on investments in small-cap stocks across a wide range of sectors by tracking a heavily diversified index. The top five holdings in the fund include BlackRock Cash Funds Treasury SL Agency (XTSLA), GameStop (GME), Crocs (CROX), Omnicell (OMCL), and Saia (SAIA).
- Dividend History: With an average dividend yield of more than 1%, the fund isn’t a major income earner, but it does fall in line with what you would expect from a highly diversified list of small-cap stocks.
- Morningstar Rating: The return rating on the ETF is 4 out of 5 stars, suggesting that historically, the fund has outperformed its peers and the market as a whole on a relatively consistent basis.
- ESG Score.: The ESG score for the fund is 4.57 out of 10, giving it a BBB rating. This suggests that the fund is slightly below average from a social perspective, which may turn off investors interested in socially responsible investing.
All told, the IJR fund is at the top of the list for a reason. It offers a highly diversified portfolio of small-cap U.S.-based companies, one that has a proven ability to beat the overall market on a consistent basis.
At the same time, the fund comes with an industry-leading cost structure, allowing you to hold onto more of your gains, while paying dividends on a regular basis. What more could an investor expect?
2. iShares Russell 2000 Growth ETF (IWO)
Another fund managed by iShares, the Russell 2000 Growth ETF is well worth looking into, especially if you’re interested in growth investing.
Growth stocks are those that have consistently yielded revenue, earnings, and share price growth that outpaces that of the overall sector in which they operate.
The fund is another passively managed option that comes with a relatively low expense ratio. However, this fund tracks a small-cap growth index made up of stocks with small market capitalizations that display growth characteristics.
Investors in these stocks hope to generate growth that outpaces the overall market. Tracking an index composed of smaller companies that display compelling growth characteristics can weed out the underperformers and provide wider exposure to the larger opportunities.
- Expenses: While this fund doesn’t come with the lowest costs in the industry, it is relatively inexpensive with an expense ratio of just 0.24%, allowing you to hold onto more of your returns.
- Historic Performance: Over the past year, investors in IWO have enjoyed nearly 70% returns, while other investments in growth-focused small-cap ETFs averaged returns of just 0.34%. Over the past three and five years, returns have come in at 17.86% and 18.88%, respectively, while industry averages were just 3.74% and 11.52%.
- Portfolio Makeup: The fund is centered around a strategy of investing specifically in small-cap equities that come with growth characteristics. Some of the largest holdings in the fund include Plug Power (PLUG), Restoration Hardware (RH), Caesars Entertainment (CZR), Deckers Outdoors (DECK), and Churchill Downs (CHDN).
- Dividend History: The fund pays a yield of about 0.4%, so you shouldn’t expect any significant income. However, its modest dividends have shown a relatively consistent growth trend, with annual payments trending upward.
- Morningstar Rating: With a return rating of 3 out of 5 stars, the IWO fund has a history of slightly outperforming the overall market.
- ESG Score: The ESG score of the fund is 4.2 out of 10, leaving quite a bit to be desired from a social investing standpoint.
Compared to its peers, the IWO fund has a strong history of performing well for investors. Moreover, while dividend payments aren’t huge, the 0.4% yield offers stable income that can be reinvested to expand your overall returns.
All in all, if you’re considering getting into the small-cap space, the IWO is a great fund to start with.
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3. Vanguard Small-Cap Value ETF (VBR)
Vanguard is another well-respected fund manager on Wall Street. Founded in 1975, the firm has several decades of service to the investing community under its belt and has amassed a massive $7.1 trillion in assets under management.
This can often be the case for smaller, lesser-known companies. Once the market recognizes the opportunity, they push these stocks closer to their intrinsic value, offering up big gains for investors who got in early.
This fund tracks the CRSP U.S. Small Cap Value Index, which is made up of smaller domestic companies that come with value characteristics. The key stats for the fund are as follows:
- Expenses: As a Vanguard fund, you can expect industry-leading low expenses, and this fund fits the bill at just 0.07%.
- Historic Performance: The VBR fund has a long history of outperforming the returns of its peers. In the past year alone, the fund generated returns of more than 75% while its peers averaged returns below 9%. Over the past three and five years, returns have come in at 12.15% and 12.87%, respectively, while the overall industry averaged returns of 4.96% and 12.52%.
- Portfolio Makeup: The fund’s portfolio is primarily made up of domestic companies with small market caps. Its top five holdings include IDEX Corporation (IEX), VICI Properties (VICI), Devon Energy (DVN), Nuance Communications (NUAN), and Diamondback Energy (FANG).
- Dividend History: With a dividend yield of nearly 2%, the income generated through investments in this fund is nothing to shake a stick at. Moreover, the fund has consistently raised its annual dividends over the past several years.
- Morningstar Rating: With a return rating of 5 out of 5 stars, Morningstar points to a fund that has a strong history of outperforming the market as a whole.
- ESG Score: With an ESG score of 4.86 and a BBB rating, the fund is slightly below average when it comes to socially responsible investments, which may turn some investors off.
All in all, the VBR fund is one that shouldn’t be ignored.
With a return rating of 5 out of 5 stars and the performance numbers backing up that rating, it’s clear investors in the fund have enjoyed the ability to outperform the market. Moreover, they’ve done so while paying very low expenses.
4. Schwab U.S. Small-Cap ETF (SCHA)
Founded in 1971, Charles Schwab, more commonly known as simply Schwab, is another money management firm with decades of history serving the investing community.
With $3.25 trillion in assets under management, the firm is one of the most trusted money managers on Wall Street and a great place to look if you’re seeking out quality index funds and ETFs.
Designed to track the returns of the Dow Jones U.S. Small-Cap Total Stock Market Index, the Schwab U.S. Small-Cap ETF offers diversified exposure to small-cap companies in the U.S. across a wide range of industries.
The key stats for the fund are as follows:
- Expenses: The fund comes with fees of just 0.04% annually, making it the lowest-cost fund on this list.
- Historic Performance: The SCHA fund is known for outperforming its peers. In the past year, investors have enjoyed gains of over 75% while returns with its peers have been just over 3% on average. Over the past three and five years, returns have clocked in at 15.37% and 15.68%, respectively, with competing funds generating average returns of 4.58% and 12.14%.
- Portfolio Makeup: Built to track the Dow Jones U.S. Small-Cap Total Stock Market Index, the fund offers up a diversified list of smaller publicly traded companies based in the U.S. The top five holdings in the fund’s portfolio include Caesars Entertainment (CZR), NovoCure (NVCR), Cloudflare (NET), 10x Genomics (TXG), and Plug Power (PLUG).
- Dividend History. With a dividend yield of under 1%, the fund isn’t turning any income investors’ heads, but it does provide consistent income that can be reinvested to increase overall returns.
- Morningstar Rating: The fund has a return rating of 4 out of 5 stars, suggesting it has a strong history of producing better returns than the overall market.
- ESG Score: The ESG score is a 4.49 out of 10, giving the fund a BBB rating. This means that the fund is slightly below average in terms of social impact investing, which may lead some investors to look for other options.
All in all, the SCHA fund is a great investment option for those looking for widespread exposure to smaller publicly traded companies in the United States.
With a mix of value, growth, and income stocks, the fund is known for beating average market returns while maintaining one of the lowest cost structures seen on Wall Street.
5. iShares Morningstar Small-Cap Growth ETF (ISCG)
The iShares Morningstar Small-Cap Growth ETF is another fund developed to track small-cap companies that exhibit growth characteristics — a match made in heaven.
However, rather than tracking the stocks that fit into this category listed on the Russell 2000 index as the IWO fund does, this fund is centered around a different small-cap index from Morningstar. By purchasing both funds, you’ll gain further diversification across the growth sector of the small-cap world.
Here are the key stats:
- Expenses: The fund comes with an incredibly low annual cost of just 0.06%.
- Historic Performance: The ISCG has consistently beaten its competitors’ returns throughout history. In the past year, investors have earned a return of more than 61%, while other funds in the category didn’t even generate a full 1% return. Over the past three and five years, returns have come in at 19.18% and 19.42%, respectively, while the industry average has been 3.74% and 11.52%.
- Portfolio Makeup: As mentioned above, the fund maintains a portfolio that tracks a Morningstar index focused on small-cap domestic stocks with growth characteristics. The top five holdings in the fund include Novavax (NVAX), Plug Power (PLUG), Restoration Hardware (RH), Lithia Motors (LAD), and Palantir Technologies (PLTR).
- Dividend History: The fund offers a dividend yield of around 0.6%, which isn’t going to be anyone’s primary reason for buying in. Nonetheless, the added income can be used immediately or reinvested to expand overall gains. Not to mention, the fund has a pretty strong history of increasing dividends year after year.
- Morningstar Rating: The return rating on the fund is 3 out of 5 stars, suggesting that, historically, the fund has outpaced the overall market on a regular basis.
- ESG Score: The ESG score on the fund is just 4.26%, meaning that there’s something left to be desired for social impact investors, as the ETF ranks below average with a BBB rating.
All in all, the ISCG is a fund that’s hard to ignore. Not only does the fund offer an extremely low expense ratio, but it outpaces its competitors on a regular basis in terms of returns.
Moreover, with a focus on stocks that are already displaying growth characteristics, you’ll be tapping into upward trends, a strategy that’s known for generating strong returns.
6. Vanguard Small-Cap Growth ETF (VBK)
Yet another fund focused on investing in small-cap companies that display strong growth characteristics, the Vanguard Small-Cap Growth ETF is a great fit for the growth investor who wants exposure to the small-cap sector.
Built to track the returns of the CRSP U.S. Small Cap Growth Index, the fund’s portfolio is made up of domestic companies with market caps below $2 billion dollars that are experiencing compelling growth in revenue, earnings, and share price, making this a highly desirable bunch of equities.
The key stats for the fund include:
- Expenses: The expenses associated with owning shares of the fund are just 0.07%, typical of a low-cost Vanguard fund.
- Historic Performance: Over the past year, investors in the fund have enjoyed a whopping 63.39% return on their investments, while other funds in the industry averaged returns at just 0.34%. Throughout the past three and five years, other funds averaged returns of 3.74% and 15.52%, while this fund blew those figures away, generating returns of 20.81% and 19.65%, respectively.
- Portfolio Makeup: With a focus on investing in small companies that are on a growth trajectory, the top five holdings in the fund’s portfolio include Bio-Techne Corporation (TECH), Charles Rivers Laboratories International (CRL), Teledyne Technologies (TDY), Pool Corporation (POOL), and Avantor (AVTR).
- Dividend History: The fund carries a dividend yield of just under 0.6%. Like most funds on this list, it has a consistent history of providing modest income that can be used to expand your long-term profitability by reinvesting your dividends.
- Morningstar Rating: With a return rating of 3 out of 5 stars, the fund has a strong history of performing in line with or better than the overall market.
- ESG Score: With an ESG score of 4.97 out of 10, the fund has a BBB rating. Its track record as a socially responsible investment is about average among ETFs.
As another option for gaining small-cap exposure while focusing on growth, the VBK is known for generating market-leading returns with some of the lowest costs in the industry. All told, this is a fund worth your consideration.
7. Vanguard FTSE All World ex-U.S. Small-Cap ETF (VSS)
Another Vanguard fund, the FTSE All World ex-U.S. Small-Cap ETF takes small-cap investing to the next level.
In addition to smaller companies being known for generating larger opportunities than their large-cap counterparts, international investments also have the potential for tremendous growth, especially when investing in emerging markets.
The VSS fund hits all of these nails on the head.
- Expenses: With an expense ratio of 0.11%, the VSS fund isn’t the lowest-cost ETF on this list, but its cost is still well below the industry average.
- Historic Performance: When compared to similar ETFs, this fund has a history of stellar performance, delivering returns of more than 56% over the past year while its peers averaged just over 11%. Over the past three and five years, returns have clocked in at 6.60% and 9.82%, respectively, far outpacing average returns among similar funds over these periods of 4.13% and 9.44%.
- Portfolio Makeup: The fund’s portfolio is made up of global small-cap equities with the exclusion of U.S. companies. Its five largest holdings are First Quantum Minerals (FM.TO), Open Text (OTEXT.TO), WSP Global (WSP.TO), Emera (EMA.TO), and Kirkland Lake Gold (KL.TO).
- Dividend History: Over the past several years, the fund has consistently increased its annual dividend payments. Moreover, with a yield of 2.08%, it provides meaningful income, making it a great option for income investors or those looking to increase their profitability by reinvesting dividend payments.
- Morningstar Rating: The fund comes with a return rating of 3 out of 5 stars, meaning it is known for reasonable returns that generally outpace the overall market.
- ESG Score: The fund comes with an ESG score of 5.38, which equates to a BBB rating. Based on the score, the fund is slightly ahead of its competitors when it comes to making a social and environmental difference through its investments, making it an attractive option for those looking to take the socially responsible approach within their portfolios.
All told, the VSS fund is a top contender among small-cap investments, delivering above-average returns at a lower-than-average cost.
Moreover, the fund offers a way to add further diversification to your portfolio through international investments while generating meaningful income.
8. SPDR S&P 600 Small-Cap Growth ETF (SLYG)
The SPDR S&P 600 Small-Cap Growth ETF is managed by State Street Advisors, the fourth largest fund manager in the U.S.
Designed to track the performance of the S&P SmallCap 600 Growth Index, the fund invests in small-cap companies that are known for their growth characteristics, paying special attention to growth in revenue and earnings, as well as share price, and the momentum of the growth in share price.
The key stats for the fund are as follows:
- Expenses: When investing in the fund, you’ll pay 0.15% of the value of your investment as annual fees.
- Historic Performance: The SLYG fund has been a stellar performer over the years. In the last year alone, the fund has resulted in more than 70% gains for investors, with the three- and five-year returns coming in at more than 15% and 17%, respectively. Average returns among the fund’s closest competitors were 0.34%, 3.74%, and 11.52% over the past one, three, and five years.
- Portfolio Makeup: With a focus on investing in small-cap stocks with growth characteristics, the fund’s five largest holdings include Crocs (CROX), Omnicell (OMCL), Saia (SAIA), NeoGenomics (NEO), and Chart Industries (GTLS).
- Dividend History: Although the fund is focused on growth stocks, it has a sporadic but compelling dividend history. Yields on the fund have ranged from just below 1% to more than 5%, depending on the year. However, there seems to be no pattern regarding the size of dividend payments offered.
- Morningstar Rating: The return rating on the fund is 3 out of 5 stars, suggesting the fund consistently performs in line with or outperforms the overall market.
- ESG Score: The fund has an ESG rating of BBB, scoring 4.90 out of 10. This suggests the fund is not necessarily known for making an environmental or social impact through its investments.
All in all, the SLYG fund is a compelling option, especially for investors looking to generate market-leading returns while getting the occasional hefty, albeit sporadic, dividend payment.
Moreover, with expenses coming in well below the industry average, investors in the fund are able to hold onto more of their returns, which makes a big difference in the long run.
9. WisdomTree U.S. Small-Cap Dividend ETF (DES)
Founded in 2006, WisdomTree is one of the younger fund managers on Wall Street, but don’t let that fool you.
The firm’s strong returns and low expenses have led to interest from the investing public and allowed the firm to amass more than $20 billion in assets under management.
The WisdomTree U.S. Small-Cap Dividend ETF was designed to provide investors with exposure to small-cap stocks representing U.S. companies that are known for paying dividends. Here are the key stats:
- Expenses: Investing in the fund will come with fees of 0.38% per year. While this is the highest ratio on this list, it’s still below the industry average.
- Historic Performance: The fund is known for producing stellar performance, especially in recent years. The fund has resulted in more than 60% returns for investors over the past year, while similar funds have averaged returns around 8.5%. In the past three years, the fund generated returns of about 7.55%, outpacing the average among similar funds of 4.96%. However, it is worth mentioning that the five-year performance hasn’t been quite as impressive, with returns of 9.56% compared to an industry average of 12.52%.
- Portfolio Makeup: With a focus on small-cap dividend payers, the top five holdings in the fund include Kontoor Brands (KTB), Vector Group (VGR), B&G Foods (BGS), Compass Minerals International (CMP), and Rent-A-Center (RCII).
- Dividend History: While the fund’s long-term performance is slightly below par, many investors look past that — especially those looking for income, as the fund is known for paying compelling dividends. Historically, the yield on the fund has been just below or just above 2%, which is impressive among the small-cap category.
- Morningstar Rating: The DES fund has a return rating of 3 out of 5 stars. This means it has a history of performing in line with the market or slightly outperforming the market on a relatively consistent basis.
- ESG Score: From a social and environmental impact standpoint, the fund isn’t going to turn any heads with its BB rating, which suggests the impact made by the fund’s investments is below average.
The DES fund is a strong choice for investors looking to take advantage of the potential growth offered by small-cap stocks while generating income through their investments.
All in all, if you’re an income investor who wants small-cap exposure, the fund should not be ignored.
10. Vanguard Small-Cap ETF (VB)
Designed to track the returns of the CRSP U.S. Small-Cap Index, the Vanguard Small-Cap ETF provides exposure to a heavily diversified group of stocks, all of which have market caps ranging from $300 million to $2 billion.
There is no focus specifically on income, growth, or value, as the fund is made up of stocks in all categories and all sectors. Here are the key stats:
- Expenses: With an expense ratio of just 0.05%, the ultralow fees make the fund incredibly attractive from a cost perspective.
- Historic Performance: The fund’s returns have been compelling to say the least, beating industry averages consistently since its inception. In the past year, investors have earned more than 70% returns, while competing funds have generated returns averaging just 3.71%. Over the past three and five years, returns have been over 16%, with competing funds’ three-year averages have been just 4.58% and five-year averages have been 12.14%.
- Portfolio Makeup: As mentioned above, the fund is made up of a mix of income, growth, and value stocks in the small-cap category. The top five holdings in the fund include NovoCure (NVCR), Steris (STE), IDEX Corporation (IEX), VICI Properties (VICI), and Bio-Techne (TECH).
- Dividend History: The fund has a history of generating yields of slightly more than 1%, which won’t turn any heads but does provide meaningful income to reinvest. Its dividend payment increases have been sporadic at best.
- Morningstar Rating: With a return rating of 5 out of 5 stars, the VB fund has a strong history of being one of the best performers in its space in terms of valuation growth.
- ESG Score: The fund comes with an ESG score of 4.91 out of 10, giving it a BBB rating, which is at or slightly below average, meaning this may not be the best investment for those looking to make a social or environmental impact with their investing dollars.
The Vanguard Small-Cap ETF may be the last on the list, but it’s definitely not the least.
With one of the lowest expense ratios and the highest possible return rating, this fund is nothing to shake a stick at and is a great fit for investors looking to add small-cap exposure to their portfolio.
While small-cap stocks do come with more risk than larger, more established companies, it’s wise to put at least a small percentage of your allocation into this category.
After all, these companies have plenty of room for growth, and diversified portfolios of smaller companies have a history of performing in line with, or better than, their larger counterparts.
Choosing small-cap stocks on an individual basis requires detailed knowledge of the market and quite a bit of research. Only those who know their way around the stock market should consider picking individual stocks.
By instead investing in diversified ETFs, you’ll gain exposure to a group of investments chosen by experts, greatly reducing your risk and increasing your potential profits.