A Modest Proposal for Diversification

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The financial theatre, my friends, is ever a source of amusement. For a decade past, we have witnessed a most curious spectacle: the large-cap companies, puffed up with the air of importance, have dominated the stage, while their smaller brethren, the small-cap stocks, have languished in the wings, lamenting their lack of fortune. Fueled by the seemingly endless largesse of low interest rates and a rather excessive display of stimulus, the megacaps have enjoyed a reign most unchallenged. It was, to put it mildly, a most uneven distribution of applause.

But hark! The year 2026 has brought a change of scenery. A distinct murmur of discontent has rippled through the audience, and a rotation, a shifting of favor, has begun. Investors, weary of the predictable performance of the usual suspects, now cast their gaze upon the small caps, seeking value and, dare I say, a touch of excitement. For too long, portfolios have been weighted toward artificial intelligence and the so-called “Magnificent Seven,” a concentration of risk that any sensible player would deem… imprudent. Diversification, it seems, is not merely a word for the textbooks, but a principle for the preservation of capital.

Of Indices and Inclinations

Now, let us speak of these small-cap players. Not all are created equal, you understand. Some adhere to the Russell 2000, a rather expansive company that admits nearly any stock that can draw breath. It is a democratic, if somewhat chaotic, assembly. Others, more discerning, follow the S&P 600, a more selective troupe that demands a certain standard of performance. The difference, you see, is akin to inviting every player to a banquet versus only those who have demonstrated a modicum of skill.

The Russell 2000, bless its inclusivity, captures the 2,000 largest of the smaller companies, with few restrictions. It is a broad net, cast wide. The S&P 600, however, is a more refined selection. It requires not merely existence, but profitability – a most novel concept! A company must demonstrate earnings, both recent and consistent, to gain admittance. It is, one might say, a test of character.

Therefore, if one desires a comprehensive overview of the small-cap universe, the Russell 2000 may suffice. But if one seeks quality, a degree of financial stability, the S&P 600 is the more judicious choice. For, as any seasoned investor knows, a profitable enterprise is far more likely to weather the storms of the market.

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The iShares Core Small Cap ETF, you see, follows the S&P 600. And I confess, I find this a most sensible arrangement. Roughly 40% of the Russell 2000 are unprofitable, prone to sharper declines when the winds shift. The S&P 600’s insistence on earnings mitigates this risk, providing a degree of reassurance in these volatile times.

A Change of Scenery

The composition of the small-cap stage differs markedly from that of the S&P 500. It is a more cyclical affair, weighted toward financials, industrials, and consumer discretionary stocks. This makes it a valuable diversifier, capable of performing differently than large caps in various environments. When the prevailing winds favor value stocks or the economy accelerates, the small caps are well-positioned to benefit.

Thus far in 2026, we have observed periods where the technology giants and megacaps have faltered. Pairing these investments with a small-cap ETF, whose portfolio and composition differ so significantly, can help balance risk and reduce the severity of any downturn. It is a matter of prudence, my friends, a recognition that even the most majestic of players can stumble.

The Pendulum Swings

It is a common folly to ignore or dismiss areas of the market that have underperformed for extended periods. Until recently, small caps, value stocks, dividend stocks, defensive equities, and bonds all suffered from a similar fate. But the market, like a fickle audience, is prone to changing its affections. There are always times when the pendulum swings in the opposite direction.

Maintaining a balanced portfolio reduces the need to attempt to time the market, a pursuit that rarely ends well. Adding exposure to small caps, such as through the iShares Core Small Cap ETF, to a large-cap-heavy portfolio accomplishes precisely that. It is a modest proposal, perhaps, but one that may save you a considerable amount of grief. And in the theatre of finance, as in life, a little prudence goes a long way.

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2026-02-22 14:54