How to Invest in the Russell 2000 Index (U.S. Small Cap Stocks)
Investing is a very personal endeavor. You have to closely examine several aspects of your life to determine if you should start investing.
Each person or family has different goals, timelines and risk tolerances. Some investors may be able to handle more risk in exchange for the potential for a greater return. Commonly, that approach will focus on small-cap stocks.
The Russell 2000 index is one of the most popular market indices that track 2,000 small-cap companies.
The Russell 2000 index has had an average annual total return of 13.62% over the last ten years as of August 31, 2021.
If that sounds promising, here’s what you should know before you start investing in the Russell 2000 index, as well as how to get started.
What is the Russell 2000 Index?
The Russell 2000 Index is comprised of the stocks of roughly 2,000 small-cap companies.
A small-cap company isn’t strictly defined but generally has a market capitalization of less than $2 billion.
Some companies in the Russell 2000 have market capitalization larger than the $2 billion mentioned above. In fact, the index is composed of the lower two-thirds of the stocks in the bigger Russell 3000 index.
This explains why some of the companies exceed that $2-billion categorization.
FTSE Russell currently manages the index.
Investors often use this fund as a benchmark for small-cap index funds to compare how their investment is fairing.
The Russell 2000 Index is a bit outside of the typical indexes quoted in the news because it focuses on smaller companies. Some people use this as a bellwether of the economy as a whole since it doesn’t include some of the largest companies in the nation.
Why You May Want to Consider Investing in This Index
You may consider investing in the Russell 2000 Index for several reasons.
Ultimately, the best reason to invest in the Russell 2000 Index is that it can help you reach your investment goals.
The Russell 2000 Index is composed of about 2,000 companies.
Owning such a wide variety of companies helps prevent you from having all of your money in a single investment.
If one company fails and becomes worthless, you’re still investing in about 1,999 other companies that could offset that loss.
Exposure to a different part of the market
Most people hear of the major stock indexes, such as the S&P 500, Nasdaq, and Dow Jones Industrial Average.
These indexes normally invest in much larger companies than the Russell 2000 Index holds.
Choosing to invest in the Russell 2000 index can give you exposure to the smaller companies the index holds. This provides diversification beyond the massive behemoth companies the major indexes hold.
As of August 31, 2021, the Russell 2000 index has had an average annual total return of 13.62% over the past ten years.
While past performance is no guarantee of future performance, the index has provided growth opportunities. As with any investment, there is also the risk that the Russell 2000 Index could decrease in value.
It has done so in the past and can do so again in the future. Understand these risks before you start investing in any investment.
Ways You Can Invest in the Russell 2000 Index
You can invest in the Russell 2000 index in several ways.
Some are much more practical than others.
Which you choose is a matter of preference and practicality.
Stocks are pieces of ownership in a company.
Technically, the Russell 2000 Index is made up of the stocks of roughly 2,000 companies.
In theory, you could purchase all of the stocks in the index and weight them the same as the index does to build a custom portfolio.
The amount of money and effort this would take would be massive.
As the index changes, you’d constantly have to be buying and selling stocks. For this reason, companies have come up with more viable alternatives.
Mutual funds are companies that pool investors’ money and use it to purchase a portfolio of investments.
Investment professionals manage mutual funds. These professionals purchase the same investments that the Russell 2000 Index holds in an attempt to mimic the returns of the index.
Unfortunately, you won’t get the exact returns of the index by buying shares of a mutual fund.
The index can make changes to its composition. Unless the fund makes the change at the exact same instant as the index, returns may vary slightly.
Mutual funds also have costs to run them. They must fulfill regulatory requirements. They must also pay the professionals that manage them. These costs reduce your returns and are represented as an expense ratio.
This is a percentage-based fee that comes out of your investment returns each year. Ideally, you want to find a mutual fund that minimizes its expense ratio to maximize your returns.
Unlike stocks, mutual funds only trade and price once per day. That means you can’t day trade a mutual fund if you’re trying to take advantage of pricing inefficiencies.
Examples of Russell 2000 Index mutual funds include:
- Vanguard Russell 2000 Index Fund Institutional Shares (VRTIX)
- MM Russell 2000 Small Cap Index Fund Class I (MCJZX)
Exchange-traded funds are funds that can be traded like stocks on an exchange.
These funds own a variety of investments depending on the goals of the fund. This means the price changes and can be bought and sold throughout the day during trading hours.
In the case of Russell 2000 index fund ETFs, they aim to hold the same investments as the index.
They’re very similar to mutual funds.
ETFs are managed professionally and have costs and expense ratios like mutual funds.
These costs plus slight timing differences result in returns that won’t exactly match the Russell 2000 index. That said, a low-cost ETF is well worth the cost of not having to purchase and track the 2,000 companies held in the Russell 2000 index yourself.
Due to how ETFs operate, the expense ratios and tax impacts of owning an ETF are usually lower than a mutual fund. This, along with the availability to trade throughout the day, make ETFs a more attractive option for many investors.
Examples of Russell 2000 Index ETFs include:
- Vanguard Russell 2000 ETF (VTWO)
- iShares Russell 2000 ETF (IWM)
Pick Your Brokerage Carefully
Depending on your brokerage, your choice of investments may vary--you may not be able to invest in a mutual fund or ETF that tracks the Russell 2000 index closely.
Clearly, you'd want to go with a brokerage that offers such investment options.
And, if you're going to be putting money into a fund on a regular basis, you must also consider any ongoing commission fees or trading costs to buy shares of that fund.
Those are just some of the factors to think about when choosing a brokerage.
How the Russell 2000 Compares to a Total Stock Market Fund
The Russell 2000 index focuses on small-cap stocks while total stock market funds typically try to capture the entire U.S. stock market.
This means the total stock market funds include the returns of the largest companies in the country while the Russell 2000 does not. This can and historically has resulted in different returns between the two indexes.
Whether the Russell 2000 or total stock market fund performs better depends on the given time period.
Over the past 3-, 5-, and 10-year periods, the Vanguard Total Stock Market ETF (VTI) has higher average annual returns than the iShares Russell 2000 ETF (IWM).
However, IWM has outpaced the returns of VTI by over 17% over the past year.
Returns quoted in this section are as of September 28, 2021.
Consult an Expert
If you’re unsure if investing in a Russell 2000 fund is the right move for you, you may want to consult an expert.
A fiduciary fee-only financial advisor is likely your best bet.
These advisors must give you advice in your best interests.
While you have to pay them for their time, they don’t accept commissions that could influence their advice.
A fiduciary fee-only financial advisor can look at your entire financial picture.
Then, they can recommend if a Russell 2000 fund could help you meet your investing goals.
If not, they may be able to suggest another path of action or alternative investments that may work better for you.