What is the best investment? Part Five: Size

The Size premium: small companies are better than large companies.

All else being equal, smaller things move faster, farther, and more efficiently. Even when falling. Given two burdens, one larger and heavier than the other, which would you choose to carry?

Remarkably, investing is similar.

There is a mentality in investing that says you should invest in companies that you recognize, believe in, that have a long record of dependability. [There is some prudence here: one should not invest retirement savings in companies that are less than five years old or that have been publicly traded for less than one year.]

Think of Apple, Microsoft, Amazon, Facebook, Google (traded as Alphabet, Inc.), Berkshire Hathaway, or others like them. These companies trade at several times their book value, and each has a market capitalization of many hundreds of billions of dollars. They are the biggest of the big.

In contrast, think about companies like Toll Brothers, Arrow Electronics, Tetra Tech, Horizon Therapeutics and others like them. How about Sul America or Spar Group? These companies are small.

The risk that these companies will fail is far higher than the risk from the large companies listed above. Yet, your brain should be singing a song right now: more prudent risk, more reward.

Small size brings high risk. When we prudently diversify into smaller asset classes, we can reasonably expect higher returns over the long term (i.e. greater than ten years). In our Three Factor Model, this Factor is called the size premium.

Ugly Truth: the last thing you want more of is US large growth companies (the ones you can recognize and depend on).

Beautiful Truth: prudent diversification makes investing dependable, no matter how risky the underlying equities.

Simon Joshua is a licensed investment advisor representative at Cornerstone Wealth Partners in Michigan. He has structured his practice around investor coaching and committed himself to leading communities in establishing a legacy of fulfillment.

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