These Stocks Can ‘Give You Better Growth Potential’ with ‘Less Volatility,’ Says Expert: They’re a ‘Sweet Spot’

Ryan Ermey

Investors tend to ignore midsize-company stocks, but holding them has boosted investor returns over the long term. Here’s why.

Whether they’re willing to admit it or not, every parent has a favorite kid. You know it, your mom knows it, and your little brother definitely knows it. The people who write about, analyze, and invest in the stock market play favorites too. Our golden child: large-company stocks.

It only makes sense: Large firms offer a ton of the products and services you use every day, and because stock market indexes are typically weighted by market capitalization a company’s share price multiplied by shares outstanding – essentially, how “big” a company is movements in big companies’ share prices have an outsize effect on markets.

Of course, investors have a soft spot for small-capitalization stocks as well. After all, just about everyone dreams of buying stock in a tiny company that grows into the next Alphabet or Amazon.com.

But if you’re assembling a portfolio for the long term, don’t ignore the middle child.

Midsize-company stocks combine some of the best elements of their larger and smaller counterparts, and, over-time have represented an investing sweet spot, says Todd Rosenbluth, director of mutual fund and exchange-traded fund research at investment research firm CFRA. “Relative to large-caps, they give you better growth potential. Compared with small-caps, they’re less volatile and provide more dividend income potential,” he says.

What mid-caps are and why they’re overlooked

What constitutes a mid-cap stock depends on who you ask. The range in market capitalization that you typically hear is between $2 billion and $10 billion. But depending on which mid-cap index you’re tracking, that range can vary. Market caps for the mid-cap benchmark constructed by index provider CRSP, for instance, range from $372 million to $38 billion, while the S&P MidCap index generally aims to include stocks with market caps ranging from $2.4 billion to $8.2 billion. More on the differences between indexes in a minute.

Regardless of who’s constructing the benchmarks, mid-caps – which lack the excitement of small companies or the name-recognition of large names – tend to be overlooked. Data from S&P Dow Jones Indices shows that U.S. stock mutual funds hold small- and mid-caps at about equal levels, despite mid-caps outweighing small-caps 2-to-1 in broad market indexes.

What’s more, investors have fewer options to buy mid-cap portfolios: Mutual fund companies offer fewer mid-cap funds compared with large- and small-company stock funds.

Add mid-caps to boost long-term portfolio performance

Over time, investing the forgotten middle children has paid off. Over the course of rolling 10-year periods investment return periods that overlap with one another from July 1995 through June of this year, mid cap stocks outperformed large-caps 94% of the time and eclipsed small-caps 98% of the time, according to research from investment advisory Carillon Tower.

Mid-caps haven’t shone of late. So far this year, the S&P MidCap 400 index has lost 5.7% – better than the 12.2% decline in the S&P SmallCap 600, but far behind the 15.5% return in the large-company S&P 500. The lag makes now a good time to bolster your mid-cap holding, says Jason Draho, U.S. head of asset allocation, Americas, at UBS Global Wealth Management.

“Mid-caps tend to perform better in the recovery phase coming out of a recession,” he says. He expects a performance uptick among midsize firms in the next 6 to 12 months.

Novice investors should distribute their allocations to U.S. large-, midsize, and small-company stocks to be roughly in line with a total-market index, such as the Russell 3000, Draho says. That benchmark’s allocation to mid-caps is currently about 18%. That’s a good place for investors to start, he says. “Once you deviate from that market weight, you’re making an active call.”

To boost your exposure to mid-caps, or to get started if you’ve been ignoring them, consider adding one of several available low-cost ETFs that track mid-cap indexes. But check the holdings before you buy, especially if you already hold small- and large-cap funds, says Rosenbluth: “Depending on the make-up of the index the ETF tracks, you could end up with overlaps or gaps in your holdings.”

The Vanguard Mid-Cap ETF, for instance, tracks the aforementioned CRSP index that boasts an average market cap of about $19 billion and holds names, such as Digital Realty Trust and Chipotle Mexican Grill, that you’ll also find in major large-cap indexes. Such a fund is likely to behave more like a large-company fund than, say, the iShares Core S&P MidCap ETF, which has an average market cap of $5.2 billion.

The easiest way to avoid repeating a stock or leaving one out, says Rosenbluth: invest in ETFs that track the same family of indexes. A trio of iShares Core ETFs, for instance, track mutually-exclusive S&P indexes of large, midsize and small company stocks.