Bear Market Lessons: The Advantage of Micro-Caps

by James B. Cloonan

The bear market of the last two years has hurt many investors, but it has hurt some much more than others. In general, it has hurt institutional investors and individuals who have institutions managing their money more than it has hurt individual investors who manage their own money—unless the individual failed to diversify.

The reason individuals fared better during this bear market has to do with the way individuals invest and the types of securities in which they can invest. The recent market has emphasized the importance of many of the long-term principles of successful investing.

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Once again, the advantage of micro-cap stocks has been demonstrated. Micro-caps are defined here as the stocks of companies with market capitalizations (share price times number of shares outstanding) below $125 million. In 2000, the Beginner’s Portfolio, AAII’s experimental portfolio of micro-cap stocks, was down 7.9% but the S&P 500 was down 11.1%, a 3.2% advantage. In 2001, the Beginner’s Portfolio was up 30.5% and the S&P 500 was down 12%, a 42.5% advantage. And after two months this year, the Beginner’s Portfolio has an advantage of 6%. [The Beginner’s Portfolio was started nine years ago to show that a consistent approach could be followed without great time requirements, and to examine the problems and procedures of managing a portfolio of micro-cap stocks. A complete description of the Beginner’s Portfolio, including the rules and past performance, appeared most recently in the August 2001 issue of the AAII Journal.]

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