If Big Stocks Let You Down, Think Small

BOSTON (TheStreet) -- For a very long time, many retirement portfolios have focused on big, well-known companies such as GE (GE) and IBM (IBM). Owning big blue-chip stocks has been seen as safe and profitable.

But in the topsy-turvy marketplace of recent years, this conventional wisdom doesn't always ring true. Some less prestigious companies and small-cap stocks can also boost returns, hedge against inflation and build the savings needed for longer lives.

Google
Google is a great company but a lousy investment, some say.

"Some of America's biggest and most well-known companies are hurting lots of portfolios," says Bill Gunderson, president of Gunderson Capital Management and host of a daily radio show on KCEO-AM in Oceanside, Calif. "Not only do they drag your portfolio down -- many of them have gone backwards for years."

"There are stocks of yesteryear, and there are stocks for today," he says. "Take Cisco ( CSCO), for example. Over the last 10 years it has gone nowhere; over the past three years it has given negative returns. It became a stock of yesteryear five or six years ago."

Other "stocks of yesteryear," in his opinion, are Google ( GOOG), Pfizer ( PFE), Microsoft ( MSFT) and Intel ( INTC).

"Great companies all, but lousy as investments," Gunderson says.

Many investors look at these recognizable names as though "there is a warm blanket being wrapped around them," he says, but favorable associations are not enough; one has to dig into their actual track record.

Many mutual funds, a core holding of 401(k) plans, tend to load up on such companies, which can be bad news for those saving for retirement, Gunderson says.

"General Electric is probably one of the most widely held, well known stocks in the world," he says. "If you look at GE over the last 10 years, it is down about 60% during that period of time. On the other hand, during that same time, you have a stock like Priceline ( PCLN) that is up 600%."

Instead of riding on the past glory of Microsoft, Gunderson prefers up-and-coming companies such as AutoZone ( AZO) and Dollar Tree ( DLTR) to build returns and provide diversification.

An alternative to going big is to think small.

Investors often underestimate the value of small-cap stocks in their retirement portfolio, says Casey Smith, president of Wiser Wealth Management in Marietta, Ga.

On his firm's website, Smith writes: "In 401(k) investing, there is a major asset class that does not get the respect it deserves. In fact, it is largely ignored both by investors and plan sponsors. This asset class, small-cap stock funds, is a very important element in a 401(k) plan. Throughout the history of the stock market, small-cap stock funds have significantly outperformed their larger counterparts."

"Small caps should rank in every single portfolio," he says. "The question is at what percentage. If you look the standard deviation and the risk of small caps, they are still greater than the large-cap stocks. However, for most people you need to take a little bit of that risk to help you keep up with inflation within the portfolio."

He points out that "small-cap stocks should not be a centerpiece for a portfolio, but certainly a building block ... There is a case for small-cap stocks outperforming larger stocks, but we need to remember that larger stocks tend to be more stable, which is why investors, over the long run, are compensated less."

His firm relies on an index-based approach, typically using the S&P SmallCap 600 and investing in ETFs. In its most aggressive portfolios, up to 16% is earmarked for small caps.

"Small-cap stocks have proven to be a long-term healthy asset class," Smith says. "That's certainly a reason we subscribe to them in every single portfolio."

Smith says that, over the past 15 years -- and in past decades -- small-cap companies significantly outperformed the large-cap S&P 500, despite underperformance during the tech bubble.

The reason: "Smaller companies tend to grow at a faster rate and, over time, larger companies still grow, but much more slowly," Smith says.

"Smaller companies have less economies of scale, less complex capital structures, less debt and lean more on a competitive advantage, which can quickly change," he wrote. "What it all boils down to is that smaller companies are more risky, and the investor is compensated for that risk in the long run. This works just the same way a bank demands a higher interest from a person with a lower credit score or a higher risk of default. The market demands that same kind of compensation."

An index-based approach is more desirable, especially for the average investor, Smith says.

"There's just no way that the layperson or person on the street could pick a small-cap stock every single time that would be a winner," he says. "You run the risk of losing everything, but you also have the potential of gaining everything."

Investing in an index avoids tease highs and lows to find a safe, comfortable return in the middle. As Smith puts it, "the turtle wins the race."

"A lot of people think that small-cap stocks are like Billy's Bake Shop, with three employees, and he's doing good if he makes his rent payment," Smith says. "But that's not a small cap. That might not even be a micro-cap."

Ways for retail investors to add small caps to their portfolio include iShares' S&P Small Cap 600 Value Index Fund ( VTI). Smith recommends a look at the Vanguard Total Stock Market ETF VTI for those who are unsure of a proper allocation. Its mix of large, mid and small caps allows you to "grab some of that small-cap exposure at a cost of less than 20 basis points," he says.

Vanguard also offers "completion indexes" of small and midcap stocks that complement large-cap holdings, such as the Vanguard Extended Market ETF ( VXF).

Gunderson stresses that one shouldn't necessarily avoid large-cap stocks completely. There are still good buys to be had. It is up to investors, however, to research them, and not just go with names that resonate.

"You can find the best large caps of today. You don't have to necessarily go down to the small cap," he says. "For instance, Caterpillar ( CAT) is one of the most phenomenal large caps in the market today ... and it is not that expensive. Over the last 10 years, the market has gone nowhere, it is flat. But Caterpillar has averaged 20% a year in returns during that same time. Wal-Mart ( WMT) has gone nowhere for 10 years, yet Dollar Tree was up 60% in 2008, even at the height of the recession."

-- Written by Joe Mont in Boston.

>To contact the writer of this article, click here: Joe Mont.

RELATED STORIES:


More from Retirement

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Retirees Should Avoid These 7 Stocks

Retirees Should Avoid These 7 Stocks

3 Great Stocks for Retirees to Own

3 Great Stocks for Retirees to Own

3 Complicated Investing Strategies Millennials Love

3 Complicated Investing Strategies Millennials Love