The Case for Small-Cap Value
Stocks can generally be broadly categorized into the following 4 main segments:
- Large Cap Value (LCV): these are well known “boring” companies (Exxon, Wal-Mart, Berkshire, Home Depot, etc)
- Large Cap Growth (LCG): these are well known “exciting” companies (Microsoft, Nvidia, Apple, Amazon, etc)
- Small Cap Value (SCV): these are relatively unknown “boring” companies that are still profitable
- Small Cap Growth (SCG): this is where people are hoping for that lottery ticket of finding the next Google or Microsoft
You might think that the returns from finding the next big thing hiding in that small cap growth bucket would outpace everything else, however, the opposite has been true historically, by a pretty large margin.
This graph shows what $1,000 invested in 1972 would end up at today depending on the asset class you picked:
(Source: data from www.portfoliovisualizer.com)
Historically, SCV stocks have delivered higher returns on average over the long term than the other 3 groups. The premium is thought to come from a combination of:
Risk-based factors: These companies tend to be riskier. They may be more vulnerable in recessions, have less access to capital, or operate in competitive, niche markets. Investors demand higher long-term returns for bearing these risks.
Behavioral factors: Wall Street and everyday investors often overlook boring, beaten-down companies. That neglect can leave them undervalued, setting up higher future returns.
Beyond the earlier chart, we can even look at more specifics over the last 50 years from portfoliovisualizer.com. The compound annual growth rate is the highest with small cap value and the lowest with small cap growth. We do see that the standard deviation (i.e. measure of risk) is slightly higher for the SCV versus either of the large cap groups, but still significantly less than SCG. With SCG, you get the lowest returns and the highest risk which is another reason there has been a heavier emphasis on tilting toward SCV since it not only takes advantage of these larger historic returns, but also tilts away from the underperforming SCG sector.
But Doesn’t VTSAX Already Have Small Cap Value Stocks?
It’s true. If you already own VTSAX, you already own SCV stocks — just not much. In a market-cap-weighted index (like VTSAX, VTI, and nearly every index fund out there), mega-cap growth companies dominate. Here is the sector weighting for VTSAX or VTI
Only 3% of the entire portfolio falls into that SCV sector with 72% of the portfolio being in the large cap sectors. That’s not a lot of exposure into what we’ve seen as the highest returning asset class historically.
By intentionally “tilting” toward SCV (say, adding a dedicated 10–20% slice), you:
- Increase exposure to a historically higher-return segment.
- Add diversification — SCV doesn’t always move in sync with large-cap stocks
- Potentially smooth long-term returns, even if it makes the short-term ride bumpier.
For example, during the 2000–2002 dot-com crash, LCG stocks were down 22% in 2000, down 13% in 2001, and down 23% in 2002. Meanwhile SCV stocks were actually up 22% in 2000 and 14% 2001 though did have a 14% decline in 2002. This added allocation to SCV can be extremely powerful for people who are withdrawing from their portfolio, to provide a better chance of having some sort of asset class that is performing well, even if their other asset classes are down that year.
The Trade-Offs (There’s No Free Lunch)
- SCV can lag for long stretches - Sometimes a decade or more. That’s brutal for impatient investors.
- More volatility - Smaller, cheaper companies can swing wildly in value.
- Behavioral risk - If you bail during underperformance, you lose the benefit, so this has to be a long term buy-and-hold strategy that you can stick with.
How to Implement Without Overcomplicating
A common “tilt” looks like:
- 80% Total Stock Market (VTSAX or VTI)
- 20% SCV ETF
Some go even further. Paul Merriman, financial educator and advisor, is one of the most well-known advocates for the small-cap value strategy, and he will sometimes mention portfolios that are up to 50% SCV. That high of an allocation can take some significant mental fortitude to handle the large volatility and lengthier stretches of underperformance. Be sure to pick a strategy you will stick with based on your own personal risk tolerance and timeline.
If you decide to explore SCV, keep it simple. Options include:
- Vanguard Small-Cap Value ETF (VBR) — low cost (0.07% as of August 2025), good fit for taxable or tax-advantaged accounts. Follows the CRSP Small Cap Index. Often considered less small and less “value-y” than the next 2 options, so you might consider a higher allocation to this fund relative to your total market fund to account for the difference.
- Avantis Small-Cap Value ETF (AVUV) — higher fees (0.25% as of August 2025) because it’s not a true index fund, but more aggressive screening for value and profitability. This is the ETF often mentioned as Paul Merriman’s favorite. Benchmarked against the Russell 2000 index.
- iShares S&P Small-Cap 600 Value ETF (IJS) — another solid choice as a somewhat low cost (0.18% as of August 2025) index fund option, but the expense ratio is higher than VBR. Follows the S&P 600 Value index.
Bottom Line
If you love the simplicity of “VTSAX and chill”, you don’t need small-cap value. You’ll likely reach financial independence just fine without it as long as you are spending less than you make and investing the difference.
But if you’re comfortable with more volatility, willing to commit for decades, and want to squeeze a bit more juice out of the market’s history, SCV is worth a look. Just remember — the “value” only shows up if you stay the course.
It’s not about chasing higher returns year to year. It’s about stacking the odds slightly more in your favor over a lifetime.