Betting on Small-Caps: A Leveraged ETF to Avoid and a Low-Cost Option to Consider

Small-cap stocks have underperformed large caps in the past decade, but experts believe the trend may change in the coming years due to potential downward interest rates and a valuation gap between small-cap and large-cap stocks. The Vanguard Russell 2000 ETF is a cost-effective and diversified way to invest in U.S. small-cap stocks, while a leveraged ETF is generally a losing strategy to bet on a long-term trend.

Small-cap stocks have historically underperformed large-cap counterparts, a trend that has persisted over the past decade. Over the past ten years, the Vanguard Russell 2000 ETF (NASDAQ: VTWO) has delivered a 106% total return compared to the 257% return from the large-cap Vanguard S&P 500 ETF (NYSEMKT: VOO) [1]. However, experts believe that this trend may reverse in the coming years due to several factors.

One of the primary reasons for small-cap underperformance is the impact of rising interest rates. Over the past decade, the benchmark federal funds rate has increased by 400 basis points, disproportionately affecting small-cap stocks [1]. Additionally, the surge in artificial intelligence investment and the strong performance of mega-ap tech stocks have fueled the S&P 500's outperformance [1].

Despite these challenges, there are reasons to believe that now could be a good time to add small-cap exposure to your portfolio. Most experts agree that interest rates are likely to move downward in the coming years, which could benefit small-cap stocks [1]. Furthermore, there is a significant valuation gap between small-cap and large-cap stocks, with small caps currently appearing cheap [1].

The Vanguard Russell 2000 ETF is a cost-effective and diversified way to invest in U.S. small-cap stocks. It tracks the Russell 2000 index, which invests in 2,000 different companies, and has an expense ratio of 0.07% [1]. While leveraged ETFs, such as the Direxion Daily Small Cap Bull 3X Shares ETF (NYSEMKT: TNA), can be useful for short-term trading, they are generally not suitable for long-term investments due to their daily reset mechanism and the unfavorable mathematics of daily leveraged returns [1].

In conclusion, while small-cap stocks have underperformed large caps in the past decade, there are signs that the trend may change in the coming years. Investors should consider adding small-cap exposure to their portfolios, but should be cautious about leveraged ETFs for long-term investments.

References:
[1] https://finviz.com/news/99843/1-small-cap-etf-to-buy-hand-over-fist-and-1-to-avoid