You can make more money on small-cap stocks by playing this overlooked index

The Russell 2000 Index is the most inclusive, but it has not been a stellar performer over the long haul.

  • By Philip van Doorn,
  • MarketWatch
  • Investing in ETFs
  • Exchange-Traded Funds
  • Small-Cap Stocks
  • Investing in ETFs
  • Exchange-Traded Funds
  • Small-Cap Stocks
  • Investing in ETFs
  • Exchange-Traded Funds
  • Small-Cap Stocks
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Small-cap stocks are where the action is these days, and you might have seen headlines saying the benchmark Russell 2000 Index (.RUT) has been hitting record after record.

But if you are looking for broad exposure to small-cap U.S. stocks, it pays to be more selective.

This was made quite clear when we recently looked at the best-performing small-cap sector — health care.

The Russell 2000 Index is made up of the (roughly) 2,000 smallest stocks, by market capitalization, of the Russell 3000 Index (.RUA). The Russell 3000 “contains the largest 4,000 U.S. companies,” according to FTSE Russell’s methodology. That’s it. There’s no trimming for quality. You get the good with the bad.

But the S&P Small Cap 600 Index (.SML) has been a far better performer over just about any period you look at. First, here’s a five-year chart comparing the two:

Here’s a 10-year chart:

And now, 20 years:

Here’s a table with more comparisons of total returns for the two indexes:


So the Russell 2000 Index beat the S&P 600 Small Cap Index during 2017. But for all the long-term periods, it’s pretty clear which one has done a better job bringing home the bacon.

Differences between the indexes

As you saw above, the Russell 2000 doesn’t really have any criteria restricting inclusion. As of the close on Friday, there were 15 stocks in the index with prices below a dollar and 39 below two dollars. Those numbers in themselves don’t mean very much. However, it’s generally a bad sign for any company’s share price to be that low.

The S&P 600 had no stocks with share prices below a dollar as of Friday’s close, and only three with prices below two dollars.

In its criteria for companies to be initially included in the S&P 1500 Composite Index (.SPSUPX) [which includes the large-cap S&P 500 (.SPX), the S&P Mid Cap 400 Index (.MID), and the S&P 600], S&P Dow Jones Indices (.DJI) has a “financial viability” component requiring the sum of a company’s most recent four quarters of GAAP earnings to be positive.

Later on, a company that “substantially violates one or more of the eligibility criteria may be deleted at the Index Committee’s discretion,” according to S&P Dow Jones Indices. After that, a year must pass before the company can be reconsidered by the committee to be included in the index.

So the S&P 600 can be considered “less risky” than the Russell 2000, even as it has generally been the better performer.

Low-cost ways to play

There are various mutual funds that track the S&P 600 Small Cap Index. The open-ended funds tend to have various share classes with different account minimums and availability, depending on how they are distributed. If you wish to have an S&P 600 index fund within your 401(k) or other retirement account, call your plan provider and ask what is available. You need to know the fund’s total annual expenses and make sure it really is designed to track the index.

Here are three exchange-traded funds that track the S&P 600 Small Cap Index, along with their total annual expenses:

  • iShares Core S&P Small-Cap ETF (IJR) — This is, by far, the largest ETF tracking the index, with $41.7 billion in assets. The fund’s annual expenses total 0.07% of assets, according to Morningstar. That means you pay 70 cents in expenses for every $1,000 invested.
  • SPDR S&P 600 Small Cap ETF (SLY) — $1 billion in assets and total annual expenses of 0.15%.
  • Vanguard S&P Small-Cap 600 ETF (VIOO) — $892 million in assets and total annual expenses of 0.15%.

All three ETFs are rated five stars, the highest, by Morningstar.

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