Large-Cap vs. Small-Cap Stocks: Which Should I Choose?

The terms “large-cap” and “small-cap” describe a company’s market capitalization or the total dollar market value of a company’s outstanding and restricted shares of stock. Large-cap stocks are shares in very large businesses, while small-cap stocks are issued by smaller public companies.

While both types of stocks represent an ownership share in a business, the contrasting size of the companies that issue them means they can act very differently in your portfolio.

What’s the Difference Between Large-Cap Stocks and Small-Cap Stocks? 

Valuation

What defines a large-cap stock and a small-cap one is the valuation of the company that the stock represents.

While there isn’t a single set definition, large-cap stocks generally are issued by any company worth $10 billion or more, while small-cap stocks come from those worth between $250 million and $2 billion. Because stock prices change on an almost daily basis, companies could move in and out of these ranges often, which is why there isn’t a hard-and-fast rule on what market capitalization fits each category.

Stability

Market capitalization can be used as a very rough indicator of a company’s stability. Larger businesses typically have more financial resources and have been established longer. That means they’re better able to weather a financial downturn or another negative event.

Small caps are usually businesses that are newer or haven’t expanded much. They might be reliant on just a few customers, and they might not have the capital to survive a downturn in business, which makes them riskier.

When investing, it’s important to keep in mind that there’s no guarantee that any business will continue to grow—or ultimately fail. Issuers of large-cap stocks can still go bankrupt, and small-cap stocks can survive poor economies to grow into huge businesses. However, many investors use the market cap as a gauge of risk and stability.

Growth Potential

In general, large-cap companies are less likely to experience huge gains in value, while small-cap stocks have better chances of explosive growth.

If a company has attained large-cap status, that typically indicates that the business is relatively mature and established. There’s less room for it to grow compared with a small-cap business, which may still have the potential to expand to new regions or add to its product line, giving it the opportunity to significantly increase in size and revenue.

Dividends

When companies have additional income that they do not want to reinvest in growing the business, one of the ways they return value to investors is by paying dividends. Large-cap companies that are more established typically are more likely to pay dividends, as they don’t need to reinvest all their profits into growing the business.

Small-cap companies are more focused on expanding and maturing the business, meaning they will want to put every dollar they can afford toward reinvesting back into the company.

Which Is Right for You?

While large-cap and small-cap stocks are both forms of equity, they can behave very differently in your portfolio.

In general, large caps are more stable. They experience less growth but may lose value during a market downturn. Investing in certain large caps, like blue chips, which pay dividends, is a good way for investors to produce income from their portfolios.

Small-cap companies are a higher-risk, higher-reward stock investment. They have more growth potential, but also more chances for failure if things don’t go well.

If you want a more stable investment portfolio or to turn your portfolio into a source of income, large-cap stocks are likely your best bet. If you can handle the volatility of small caps and have a long time horizon for your portfolio, small caps may offer larger returns in the long run.

A Best-of-Both Worlds Option

If you’re looking for the best of both worlds, keep in mind that there’s no rule that you have to invest solely in one category of stock. You’re free to buy shares in whichever companies you want.

You can construct your portfolio based on your risk tolerance. Investors who are willing to risk more for larger rewards can weigh their portfolios more heavily toward small caps. Those who want more stability with the potential to earn significant returns from a new company, for example, can focus on large caps while holding a small allocation of small-cap stock.

Large-Cap vs. Small-Cap Funds

Investors who don’t want to buy shares in individual companies can consider investing in mutual funds that focus on large-cap stocks or small-cap stocks. Mutual funds let investors get exposure to hundreds of different securities while only having to buy shares in a single fund. This makes it much easier to build a diversified portfolio.

There are both actively and passively managed funds that focus on large caps and small caps. One popular index for large-cap stocks is the S&P 500. A popular small-cap index is the Russell 2000.

These funds typically have features similar to the individual stocks that comprise them. Large-cap funds will tend to be more stable with less growth potential, while small-cap funds will have higher volatility but potentially greater long-term returns.

The Bottom Line

The difference between large-cap and small-cap company stocks is one of size. Large-cap stocks are issued by larger, more established businesses; small-caps represent ownership in smaller businesses that are still in a growth and expansion phase.

Investors can choose which to add to their portfolio based on their investing goals. Generally, large caps tend to offer stability and potential dividend payments, while small-caps can provide higher risk and rewards. You can also build a portfolio that mixes these two types of shares to get exposure to both segments of the market.