The Second Secret of Small-Cap Investing: Invest for the Long Term (but Monitor in the Short Term)
Successful stock investors know that a long-term approach often pays off by allowing individuals to ride out a company’s temporary setbacks and realize gains over a period of five years or a decade or even longer. In addition, minimizing transaction costs and short-term capital gains taxes can add to the overall rates of return.
With small-cap stocks, however, some tweaking to the buy-and-hold strategy used in a large-cap stock portfolio may be necessary. Because smaller companies are less established, there is often a higher degree of risk and volatility involved in holding these kinds of stocks. That’s not to say that a buy-and-hold approach can’t work, though, but just a reminder that “buy and hold” does not mean “buy and forget.” With small-cap stocks it can be prudent to maintain a somewhat higher level of vigilance on their activities, watching for signs of trouble and selling promptly when real problems affect a company.
When problems do arise, the market is often less forgiving of small companies when they hit roadblocks. Even when management eventually steers these companies back in the right direction,investors may stay away until they are receive excessive degrees of reassurance, keeping stock prices depressed all the while.
It’s never good to be swayed into action by irrational market moves, however, and patience is frequently required to become a successful stock investor. Smaller companies often don’t have the broad institutional interest required to support share price growth. As a result, stock prices may only grow moderately until a tipping point is reached, at which the market seems to wakes up to the potential of a company. Investors who have already discovered the stock will then be nicely rewarded.
Next: the third secret to small-cap investing: Pay Particular Attention to Valuation.
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