Diversifying Investments With Market Capitalization

Introduction

Market capitalization, also known as market cap, is a measure of the fair market value of a publicly traded company by multiplying a company's shares by the current market price of one share. It is a key indicator of a company's size, and it serves as a barometer of investor sentiment and the perceived value of a company.

Investors looking for long-term success should diversify their portfolios with investments of varying market capitalization. This can provide great returns and mitigate risk. Here are some of the main benefits of diversifying investments with market capitalization:

• Minimize risk
• Diversified across sectors
• Potential for greater returns
• Evaluating a business model

Types of Market Capitalization

Market capitalization is an important tool used to categorize stocks in the stock market. It describes the value of a company and is determined by the total value of the company's outstanding shares. It is used by investors to assess potential investments. There are four types of market capitalization: large-cap, mid-cap, small-cap, and micro-cap.

Large-Cap

Large-cap stocks are classified as those with a market capitalization of $10 billion or more. Most blue chip stocks and large multinational companies are classified as large-cap companies. These stocks are generally mature companies and their stock prices tend to be more stable than those of smaller companies. However, these stocks are not immune to market volatility and may still incur losses if market conditions change drastically.

Mid-Cap

Mid-cap stocks are those with a market capitalization between $2 billion and $10 billion. These stocks tend to be more volatile than large-cap stocks, as they may still be in the high-growth stages of their businesses. While they may provide more opportunity for capital appreciation, they also carry higher risk than large-cap stocks.

Small-Cap

Small-cap stocks are those with market capitalization between $300 million and $2 billion. These stocks tend to be the most volatile due to the rapidly changing nature of their underlying businesses and the limited liquidity of their shares. However, they also often offer the greatest potential for gains, as well as the greatest probability of losses.

Micro-Cap

Micro-cap stocks are those with market capitalization under $300 million. These stocks are typically less mature businesses and offer a greater potential for gains, but also a higher risk. It is important for investors to research micro-cap companies thoroughly before investing, as their small size may make them more vulnerable to market changes.

Benefits of Investing in Large-Cap Companies

Investing in large-cap companies, which are companies with market capitalization of $10 billion or more, carries a number of unique benefits for investors. Large-cap companies typically possess their own advantages and offer investors a particular level of stability and security.

Reduced Risk

Perhaps the chief advantage of investing in large-cap companies is the reduced risk. As more stable companies, large-cap companies can sustain potential downturns on the market and offer investors a more reliable long-term return on their investments. Because large-cap companies are typically larger and more established, they generally tend to have a greater ability to weather the storm, as opposed to smaller, more recently established companies.

Stability

The stability of large-cap companies is another major benefit of investing in them. Unlike other investments, such as penny stocks, these companies have experienced many market cycles, and as a result, are able to more accurately anticipate future performance. This provides investors with greater confidence that their investments will be more reliable over time.

Brand Recognition

Large-cap companies typically possess a certain level of brand recognition, which can benefit investors in two different ways. First, brand recognition can lead to higher stock prices, as investors are more likely to purchase a company’s stock when they know the company. Second, brand recognition can generate greater sales, leading to higher returns. This, in turn, can result in larger dividends and higher share prices, which could further benefit investors.

Benefits of Investing in Mid-Cap Companies

Mid-cap companies often offer a combination of the upside that comes from investing in small-caps, with the safety and reduced risk associated with large-cap investments.

Potentially Higher Returns

Mid-cap companies tend to have more potential for growth than large-cap firms. This can increase potential returns as the company grows in size. Additionally, mid-cap companies are often in the process of executing on their growth plans, which can result in higher returns for investors.

Safety With Reduced Risk

Mid-cap companies often have a larger free float than small-cap companies, meaning there is less chance of large swings in the stock caused by large shareholders buying or selling shares. Additionally, mid-cap companies tend to be more established than small-cap companies and have more resources to weather downturns in the market.

• Mid-cap companies often have more potential for growth than large-cap firms.
• Mid-cap companies often have a larger free float than small-cap companies, reducing risk.
• Mid-cap companies tend to be more established than small-cap companies and have more resources to weather downturns in the market.

Benefits of Investing in Small-Cap Companies

Diversifying a portfolio with investments in small-cap companies offers a range of unique benefits for investors seeking potential growth opportunities. Small-cap companies, those with a market capitalization of $300 million or less, are often rapidly expanding and highly volatile. With early-stage investments, investors gain the chance to be part of the growth process of the company, with all its potential rewards.

Potentially Substantial Growth

Because small cap firms are in the early stages, their market caps are usually small. This creates the potential for larger returns on investment than with large-cap companies because the growth of the company reflects an increase in the share price. The stock market volatility associated with small-caps can sometimes lead to substantial gains when market conditions are favorable. If a company enjoys a successful period, it can lead to impressive returns for investors.

Benefits of Investing in Micro-Cap Companies

Investing in micro-cap companies offers investors a unique set of benefits that are not commonly found with other types of investments. Micro-cap companies, defined by the U.S. Securities and Exchange Commission (SEC) as those with market capitalizations between $300 million and $2 billion, may be risky investments but the potential rewards can be just as great. Here are some of the advantages of investing in micro-cap companies.

High Risk/ High Reward

Those who invest in micro-cap companies understand that they are taking a sizeable risk. However, with this risk also comes the potential for substantially greater returns. For those who are willing and able to accept the higher risk, investing in micro-cap companies may offer much higher returns than other types of investments.

Increased Market Volatility

The stock prices of micro-cap companies are much more volatile than those of larger, more established companies. While this may initially seem to be a negative, investors may use this to their advantage. An investor may take advantage of short-term market changes and quickly jump in or out of a stock to capitalize on the increased volatility.

Long-Term Growth Potential

As small companies grow and become larger, they may enter a new phase of their life cycle where growth is more stable. This is referred to as the “growth recurrence period” and offers investors a chance to get in on the ground floor and experience a potentially massive return on their initial investments. Micro-cap companies in particular, may offer an investor a great chance at experiencing substantial long-term capital growth.

Lower Cost of Ownership

Another benefit of investing in micro-cap companies is their typically lower cost of ownership. While there may not be a lower upfront cost to purchase the stock, the cost of ownership is typically much lower. Since micro-cap companies are not as well established, their shares may be trading at a much lower price. Investors may be able to purchase products with much larger potential payouts for much less money.

Conclusion

It is critical for investors to diversify their portfolios with investments based on market capitalization. Diversification lowers risk, increases returns and ensures that an investor is protected from any sudden drop in the market. With that being said, it is important to understand the cost associated with diversification and use the advice of a financial professional for the best portfolio tailored for their individual needs.

Cost of Diversification

Diversification can not only help reduce overall risk, but can also cost additional transaction fees and higher costs of ownership. Depending on the vehicles used to diversify and the investments held, the cost of diversification could be significant and should factor into the overall return on investment.

Consider Advice from a Financial Professional

It is best to seek the advice of a qualified financial professional before investing in market capitalization assets. They can provide the best advice on what type of investments are best suited for a particular situation.

• They can provide details about sector weighting and understand the correlations of assets.
• This type of expertise can reduce costs and improve portfolio management.
• Choose a professional who understands the returns and risks of the particular investment.