Why Not Put All Your Money in Large Caps?

In recent years, a common question has emerged: why not just invest in US large companies, given their higher returns? Indeed, US large caps have outperformed other asset classes over the past decade. It’s natural for investors to think they should focus solely on these high performers. In hindsight, we might wish we had invested everything in the top performer over the past decade, but would we have made the decision to invest in all large US stocks in 2014?

Looking back 10 years, we’d likely make a different decision. In 2014, the best asset class from 2004 – 2014 wasn’t US large caps, despite their 104.13% return (JP Morgan, September 2024), but emerging markets, which were up almost double at 198% (JP Morgan, September 2014). As the chart below shows, a $100K investment in 2004 in Emerging Markets was worth close to $300,000 in 2014, while a $100,000 investment in US large caps was worth around $200,000 (JP Morgan – September 2024).

Investing in hindsight would have resulted in buying emerging markets and avoiding large US companies. Fast forward to 2024, and a 100K investment in US Large caps in 2014 is now worth over $1m, while the same investment in Emerging Markets is “only” 300K (JP Morgan, September 2024). Clearly investing based on past performance didn’t work.

Many investors experience FOMO (fear of missing out) and tend to invest heavily in recent winners, assuming they will continue to outperform. Unfortunately, markets don’t work that way. In finance, we also call this recency bias where recent narrow gains dominate investors thought process.

As shown in the chart below, large caps outpaced mid and small caps over the last 10 years, but the second chart reveals that large caps underperformed small caps over the past 25 years. This indicates that small caps outperformed large caps at some point, which was the case.

So, what is the leading long-term asset class? While returns can fluctuate and are difficult to predict, historical data over the past century shows that small-cap stocks generally outperform their large-cap counterparts.

Why does this outperformance occur? Tomorrow’s largest companies often start as small-cap companies. These smaller companies have more room to grow and can expand rapidly. Think of it like building a snowball: it starts small at the top of a hill, but as it rolls down, it gathers more snow and grows larger. Similarly, small-cap stocks have the potential to become tomorrow’s market leaders. Tomorrow’s large-cap winners either don’t exist yet or are currently small companies.

Typically, the optimal strategy is to diversify and avoid chasing last year’s top performers. The chart below illustrates the outcomes of chasing the previous year’s hottest stocks, investing in the lowest returning asset class of the previous year, and diversifying equally among asset classes.

Key Takeaway: Maintain your investments, diversify your portfolio, and avoid chasing last year’s top performers—it rarely pays off. If you have any questions, feel free to contact your Bluerock team.