The stocks of smaller, lesser-known companies can be riskier investments than those of larger firms. Smaller companies fail more often than larger, well-established ones. However, smaller companies can see explosive growth, resulting in a steep rise in their stock price. Larger companies tend to grow more slowly. You can allocate parts of your investment portfolio to each type of stock so you have opportunities for big profits but more stability, too.
Risk and Reward
The mix of smaller company stocks and larger company shares in your investment portfolio must relate to your risk tolerance. If you can stomach the roller-coaster ride some smaller stocks take, you can put a larger amount of your money into this area. If you lean more toward safety, you may want most of your money in the stocks of larger, established corporations.
Asset Allocation Models
The American Association of Individual Investors publishes model portfolios that give some guidelines. The organization says aggressive investors might put 20 percent of their money in larger company stocks and 20 percent in smaller companies, with the rest in a variety of international stocks and bonds, as well as medium-size companies. The association recommends moderately aggressive investors put 20 percent of their portfolio in larger stocks and 10 percent in smaller companies. Conservative investors may want to put 25 percent of their money in larger stocks and 10 percent in smaller ones. Bankrate recommends that investors who are 20 to 40 years old place 43 percent in largeer stocks and 10 percent in smaller shares. These percentages shrink until retirement, when the suggested breakdown is 14 percent for larger stocks and 3 percent for smaller company shares.
Bonds in the Mix
The website InvestingInBonds.com suggests adding bonds to your portfolio mix can change your view of the risks you want to take with larger and smaller stocks. You can revisit your stock mix if you consider your bonds safer than larger company stocks, such as when you buy Treasury bonds backed by the U.S. government. If you consider the money in bonds to be relatively safe, you may be willing to take more risk in smaller company stocks. On the other hand, if you want more safety than the asset allocation models offer, you could keep a high percentage in larger company stocks and add bonds to help make your portfolio even safer.
You shouldn't make your stock-allocation decisions based only on the size of the company issuing the shares, according to Charles Schwab. Other factors include who the company manager is, what industry the company is in, what area of the nation it's in and what kind of financial health the business has. All of these factors can change the amount of risk in any stock.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.