A friend announces a plan to benchmark the performance of his small-cap stocks w

Question

A friend announces a plan to benchmark the performance of his small-cap stocks with the S&P 500. Which of the following concerns should dominate your thoughts?

A. The risk and return of small-cap stocks and the S&P 500 aren’t matched. The comparison is inappropriate.

B. Problems with small-cap benchmarking were recently revealed. Russell 2000 index elements frequently change.

C. This investor is serious about managing his portfolio, and he’s on the right track, though you have suggestions for fine-tuning his approach.

D. The investor’s portfolio is too heavily weighted in small-cap stocks. This problem is an allocation error driven by demand for excess returns.

Explanation / Answer

Answer is A. The risk and return of small-cap stocks and the S&P 500 aren’t matched. The comparison is inappropriate.

One of the best indexes to use as a benchmark for small-cap performance is the Russell 2000 Index.The Russell 2000 index was created by the Frank Russell Company and it is currently comprised of 2,000 small-cap companies. These companies are U.S. equities that come from a wide variety of industries.

Another index that can be used to gauge the returns of a small-cap portfolio is the Standard & Poor's Small Cap 600 Index. The index is smaller than the Russell 2000, with only 600 equities.

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