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Investing in large cap stocks tends to be a safer way to invest in the stock market compared to other types of stocks.
But this doesn’t mean that large company stocks are free from risk.
No matter what investment you choose to invest in, you can lose money.
The question is, do large cap stocks make sense for you?
In this post, I cover the important pros and cons of large cap stocks you need to know so you can answer this question.
10 Important Pros And Cons Of Large Cap Stocks
5 Pros Of Large Cap Stocks
There are many advantages of large cap stocks.
Here are the important ones you need to know.
#1. Stable Growth
Large cap companies are a lot more stable than small cap stocks.
They are well established companies who have been around for a while and have solid product lines they can rely on to generate revenue.
And in many cases, they are not looking to drastically grow in size.
As a result, you have more predicable income and earnings, which means stable returns over the years.
So what are some of the top large cap stocks investors are putting their money into?
Here is a short list.
- General Motors
- Goldman Sachs
- JP Morgan
- Walt Disney
This is just a short list of large cap investments that make up many investors portfolios.
And if you invest in a large cap stock mutual fund or exchange traded fund, you will find many of these same stocks make up their portfolios as well.
- Read now: Learn the pros and cons of mutual funds
#2. Large Cap Companies Pay Dividends
Since most companies reinvest profits back into the company to continue to grow, the question for large caps who aren’t looking to grow is what to do with their profits.
For many of these stocks, the answer is to pay dividends.
This dividend is a way to return some profits to shareholders and as revenues rise over the years, so too do the dividends they pay.
This dividend is a great way to increase your overall investment return.
The reason is because you can take the dividend yield and add it the annual return of the stock to get your total return.
So if a stock returns 5% and the dividend is 2%, you earn 7% annually.
#3. Lots Of Research Analysis On Large Companies
While no investment is foolproof, if you are investing in individual stocks, large cap stocks give you a greater chance of earning a positive return.
One reason for this is because there are many investment analysts covering the stock, so you have various opinions and research you can rely on to help you make a good investment decision.
This is in direct contrast to small cap stocks where you might find one or no analyst covering the stock.
While this won’t eliminate your risk, it can clue you in to issues you may not have considered that can have an impact on the future of the stock.
#4. Very Liquid
Another advantage of large cap stocks is they are very liquid.
This is a way of saying if you have money invested in these companies, you can easily find a buyer for your shares and get cash in exchange.
In many cases, you can sell your shares in minutes and get the cash in a few days once the trade settles.
Investors in other asset classes outside of the stock market don’t have this luxury.
In these cases, it could be days or months until they can sell their investment.
#5. Less Volatile
The final benefit of large company stocks is they are less volatile.
This isn’t to say there won’t be fluctuations in the stock price, but this movement tends to be less dramatic than small caps.
However, if you are investing in a large growth stock, you could still experience wild swings.
This is because the company is still focusing on growing and reinvesting money into its product line.
As a result, new streams of revenue could have an impact on the share price.
5 Cons Of Large Cap Stocks
As great as these stocks are, there are drawbacks to large cap stocks.
Here are the biggest ones you need to be aware of.
#1. Large Cap Investments Won’t Outperform The Stock Market
The old adage of slow and steady wins the race applies perfectly to large caps.
You aren’t going to outperform the market on a regular basis here.
There will certainly be years where you can get an exceptional return, but in most years, you are looking between 6-8% annualized return.
The good news here is this return will still grow your wealth over time and keep you ahead of inflation.
#2. Large Cap Stocks Underperform Small Cap Stocks
Added to the above, large cap investments aren’t going to outperform small cap stocks.
Historically, small company stocks outperform large cap stocks.
And this makes sense.
Small businesses are rapidly growing as they reinvest their profits back into the business to get larger.
As a result, there is more growth potential and a greater tendency for greater movements in stock prices, and thus greater gains.
#3. Poor Dividend Yield
While getting paid a dividend is definitely a major benefit, in many cases the dividend payouts from large company stocks are relatively small.
To uniformly determine dividend rates, individual investors use the dividend yield.
This is simply dividing the annual dividend by the stock price.
So if a company pays a $2.00 dividend and the stock is trading at $45 per share, the dividend yield is 4.44%.
This is a great yield.
But most companies have a yield under 2%.
Getting 2% is better than nothing, but if you can get this rate of return by investing your money in safer investments, like bonds or even high-yield savings accounts, that might be a smarter option.
#4. Large Cap Stock Prices Could Be Too Expensive For Small Investors
As large cap stocks grow in value, so does their stock price.
It is not uncommon to see these stocks trading at $100 or more per share.
This can be a negative to most investors who don’t have a lot of money to invest.
While they could choose to not invest until they have enough money to buy shares, there are other options for them to choose from.
The most popular options are to invest in mutual funds or an exchange traded fund to gain exposure.
But doing this also means they are investing in lots of other companies they may not be interested in owning.
A good solution is fractional shares.
Here some brokers will allow you to invest in partial shares instead of whole shares.
This makes investing in high price stocks possible for those investors without a lot of money.
#5. Possible Volatility
Even though many large cap companies tend to be less volatile compared to other stocks, this doesn’t mean they can’t experience high times of volatility.
Take 2008 as a perfect example.
Over the course of just a few weeks, there were wild swings back and forth.
For example, on October 11, 2008, the S&P 500 rose 11% only to drop 9% two days later.
Later that month it was up another 11%.
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The point is, while it isn’t common, it isn’t unheard of to have periods of high volatility that effects all stocks.
Therefore, large cap investors can’t assume that their money is 100% safe.
They need to remember they are investing in the stock market and it can be a bumpy ride from time to time.
There are the important pros and cons of large cap stocks you need to know.
For most stock investors, it makes very good sense to have this investment type as part of your asset allocation.
Not only do large company stocks make a diversified investment portfolio, but they also offer stability and a source of additional income through dividends.
As a result, they can help you reach your financial goals.