With Respect to Stocks and Mutual Funds, What Is the Difference Between Small Cap and Large Cap Investments?

If you're new to the world of investing, you'll eventually need to familiarize yourself with dozens of strange-sounding terms. If you have a full-time job and simply wish to grow some of your savings in preparation for your eventual retirement, you might find this task to be time-consuming and difficult. After all, many financial professionals have years of experience and training in the field. It's difficult for an amateur investor to compete with folks who play the stock market for a living.

In fact, novices who become too cocky can make "rookie" mistakes that have the potential to produce staggering losses. If this happens to you, you might choose to avoid the stock market on a permanent basis. While this might seem like a good idea, it could cost you a great deal of money in the long run. Over time, the stock market has proven to be the most effective wealth-creating tool for long-term investors. Experienced investors generally know how to handle the market's risks without succumbing to fear or panic.

Before you can join the ranks of seasoned retail investors, you'll need to learn about the basic distinction between large-cap and small-cap stocks. As you might expect, these two terms are shorthand for "large-capitalization" and "small-capitalization." While they're typically used to describe individual stocks, they might also be used to differentiate between different types of mutual funds. Funds that are comprised of relatively small companies are generally described as "small-cap funds." Funds that contain larger companies are usually referred to as "large-cap funds."

Whereas small-cap funds may produce euphoric short-term returns during bull markets, they can be subject to tremendous amounts of volatility and have the potential to decline by 25 percent or more during short periods of time. By contrast, large-cap funds tend to be less volatile than the overall market and may pay out steady dividends. As such, they're generally regarded as "safe" investments.

To avoid confusion, large-cap and small-cap stocks and funds must adhere to certain key parameters. The "capitalization scale" is a mathematical tool that categorizes individual stocks in accordance with their market capitalization values. "Small-cap" stocks are valued at between $300 million and $2 billion. By contrast, "large-cap" stocks are valued at between $10 billion and $200 billion. Mutual funds that refer to themselves as "small-cap funds" can't buy and sell stocks that exceed the $2 billion limit. Likewise, large-cap funds can't trade in stocks that fail to clear the $10 billion threshold.

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