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The percentage of large-cap stocks in a diversified investment portfolio depends on an investor’s investment goals, risk tolerance, and time horizon.
Diversification
Diversification of an investment portfolio consists of spreading investments out into different equities or into different asset classes, such as stocks and bonds.
Diversification is enhanced by holding some investments that have a negative correlation with other held investments. With negatively correlated investments, an investor can reduce overall volatility and risk by virtue of the fact that some investments will perform better when other investments experience a downturn.
A classic diversified portfolio consists of a mix of approximately 60% stocks and 40% bonds. A more conservative portfolio would reverse those percentages. Investors may also consider diversifying by including other asset classes, such as futures, real estate or forex investments.
An investor’s age also plays an important role in diversification. Individuals closer to retirement may prefer a more conservative portfolio and look to increase their bond allocation, whereas investors who are much younger can tolerate more risk in their portfolio and thus choose riskier, higher-return investments.
Diversification Within Equity Investments
Beyond simply a mix of stocks and bonds, diversification can be further enhanced through an investor holding a combination of large-, mid-, small-, or micro-cap stocks.
Large-cap stocks are companies whose market capitalization is $10 billion or higher. They are generally considered safer investments, since they typically represent large, well-established companies that are expected to continue as profitable businesses. However, large-cap stocks usually offer less potential for high growth than mid- or small-cap companies as they already make up a large part of the market share, and as such, growth opportunities are smaller.
This is not always the case, though, as some large-cap firms, such as Google or Amazon, still offer high growth because of their presence in high-growth market sectors. Smaller-market-cap stocks usually come with both higher growth potential and higher risk levels. They have the opportunity to capture more market share but are also more susceptible to market fluctuations.
Large-cap companies also often offer dividend payouts, which can make a large-cap stock more attractive, generating higher overall returns for an investor.
How to Diversify
Achieving diversification can be done through a variety of methods. One method would be to simply choose the individual stocks yourself based on your own research. However, there are also more encompassing and simpler ways to do this. An individual can invest in ETFs or mutual funds, which provide a basket of stocks that are diversified.
Index funds are also another good option to achieve diversification as they aim to mirror a specific market index, such as the S&P 500.
The optimal mix of equities that an investor chooses is ultimately guided by individual investment goals and risk tolerance. Investors aiming for higher returns and willing to accept higher risk typically devote more of their portfolio to mid- and small-cap stocks, while more conservative investors maintain a higher percentage of large-cap stocks.
