Investing In Small Stocks

There are two main strategies for investing in small stocks and small-cap funds...

Investing in small stocks can be risky business for retail investors. Determining which stock will be the next big thing can be daunting, requiring time, effort, and careful selection. However, you can increase your chances of success with the right strategies.

It’s important to note that investing in small stocks and funds are more volatile than the S&P 500. Therefore, wise selection is crucial for retail investors choosing the “stock-pickers” strategy. Some small-cap stocks may become incredibly successful, while others might fizzle out, primarily if they rely on sales from one product.

It’s essential to remember that only a few small companies will ever become a blue chip stock. The risks in picking the wrong small stocks are significant, but the rewards for selecting the right small stocks can be substantial.

Here are the main caveats:

Smaller companies are more vulnerable to recessions, poor investments, competition, and lousy management. For example, if the CEO of a small company walks out, investors may be cautious as to whether their replacement will be on the ‘level.’ On the other hand, larger firms tend to be organizations run by many qualified professionals who can replace key personnel if the need arises.

Additionally, Wall Street often pays more attention to large corporations, meaning that small companies are typically less researched. Unless you’re careful, looming problems can go unnoticed until it’s too late to liquidate. The equally dangerous flip side is that you might overpay for a small growth stock that’s reached the very peak of its performance. After that, it’s a slippery slope for investors.

Meanwhile, low-priced ‘hot’ stocks are infamous for being bid up on the recommendation of prominent finance news outlets, BuzzFeed websites, social media influencers, or investment publications. Once the hype fades, the stock price returns to earth as original investors bail out.

One of the biggest problems with investing small-cap stocks is deciding when to sell. Almost every retail investor has made the mistake of holding on for too long or giving up before a small stock reaches its full potential. Those who refuse to admit defeat ride stocks steadily down, down, down rather than sell at a loss and move on to something else.

Final Thoughts…

To avoid these pitfalls, consider sticking with quality stocks or small-cap mutual funds instead of buying on promises or hype. Take the time to ensure there’s something solid behind the company or fund before investing your money. Research won’t completely protect you against every possible contingency, but it can save you from problems and maximize your chances of success.

Small stock mutual funds are an alternative option for retail investors. To get the best results, use the same selection criteria for big-stock funds, except for the “r2” rule.