Buy small-cap ETF when you already have large-cap of the same market
Yes, you should own a diverse mix of company sizes to be well diversified. While both will probably get hit in a recession, different economies suit different sized companies very differently in many cases, and this diversity positions you best to not only not miss out in cases where small companies do better out of recessions than large, but also in environments where small companies rate of growth is larger in bull markets.
Why would it not make more sense to invest in a handful of these   heavyweights instead of also having to carry the weight of the other   450 (some of which are mostly just baggage)? First, a cap-weighted index fund will invest more heavily in larger cap companies, so the 'baggage' you speak of does take up a smaller percentage of the portfolio's value (not that cap always equates to better performance). There are also equal-weighted index funds where each company in the index is given equal weight in the portfolio. If you could accurately pick winners and losers, then of course you could beat index funds, but on average they've performed well enough that there's little incentive for the average investor to look elsewhere.  A handful of stocks opens you up to more risk, an Enron in your handful would be pretty devastating if it comprised a large percentage of your portfolio. Additionally, since you pay a fee on each transaction ($5 in your example), you have to out-perform a low-fee index fund significantly, or be investing a very large amount of money to come out ahead. You get diversification and low-fees with an index fund. Market cap probably isn't as big of an issue as the bid/ask spread and the liquidity, although they tend to be related. The spread is likely to be wider on lesser traded ETF funds we are talking about pennies, likely not an issue unless you are trading in and out frequently. The expense ratios will also tend to be slightly higher again not a huge issue but it might be a consideration. You are unlikely to make up the cost of paying the commission to buy into a larger ETF any time soon though. Yes, this is a way to avoid the pattern day trader regulation. The only downside being that your broker will have different commission rates and your capital will be split amongst several places. It is not so useful because you are applying it to large capital. Think about Theory of Investment Value. It says that you must find undervalued stocks with whatever ratios and metrics. Now think about the reality of a company. For example, if you are waiting KO (The Coca-Cola Company) to be undervalued for buying it, it might be a bad idea because KO is already an international well known company and KO sells its product almost everywhere...so there are not too many opportunities for growth. Even if KO ratios and metrics says it's a good time to buy because it's undervalued, people might not invest on it because KO doesn't have the same potential to grow as 10 years ago. The best chance to grow is demographics. You are better off either buying ETFs monthly for many years (10 minimum) OR find small-cap and mid-cap companies that have the potential to grow plus their ratios indicate they might be undervalued. If you want your investment to work remember this: stock price growth is nothing more than You might ask yourself. What is your investment profile? Agressive? Speculative? Income? Dividends? Capital preservation? If you want something not too risky: ETFs. And not waste too much time. If you want to get more returns, you have to take more risks: find small-cap and mid-companies that are worth. I hope I helped you! Its hard to write much in those comment boxes, so I'll just make an answer, although its really not a formal answer. Regarding commissions, it costs me $5 per trade, so that's actually $10 per trade ($5 to buy, $5 to sell).  An ETF like TNA ($58 per share currently) fluctuates $1 or $2 per day.  IXC is $40 per share and fluctuates nearly 50 cents per day (a little less).  So to make any decent money per trade would mean a share size of 50 shares TNA which means I need $2900 in cash (TNA is not marginable). If it goes up $1 and I sell, that's $10 for the broker and $40 for me.  I would consider this to be the minimum share size for TNA.  For IXC, 100 shares would cost me $4000 / 2 = $2000 since IXC is marginable.  If IXC goes up 50 cents, that's $10 for the broker and $40 for me.  IXC also pays a decent dividend.  TNA does not.  You'll notice the amount of cash needed to capture these gains is roughly the same. (Actually, to capture daily moves in IXC, you'll need a bit more than $2000 because it doesn't vary quite a full 50 cents each day). At first, I thought you were describing range trading or stock channeling, but those systems require stop losses when the range or channel is broken.  You're now talking about holding forever until you get 1 or 2 points of profit.  Therefore, I wouldn't trade stocks at all.  Stocks could go to zero, ETFs will not.  It seems to me you're looking for a way to generate small, consistent returns and you're not seeking to strike it rich in one trade.  Therefore, buying something that pays a dividend would be a good idea if you plan to hold forever while waiting for your 1 or 2 points. In your system you're also going to have to define when to get back in the trade.  If you buy IXC now at $40 and it goes to $41 and you sell, do you wait for it to come back to $40?  What if it never does?  Are you happy with having only made one trade for $40 profit in your lifetime?  What if it goes up to $45 and then dips to $42, do you buy at $42?  If so, what stops you from eventually buying at the tippy top?  Or even worse, what stops you from feeling even more confident at the top and buying bigger lots?  If it gets to $49, surely it will cover that last buck to $50, right? /sarc What if you bought IXC at $40 and it went down.  Now what?  Do you take up gardening as a hobby while waiting for IXC to come back?  Do you buy more at lower prices and average down?  Do you find other stocks to trade?  If so, how long until you run out of money and you start getting margin calls?  Then you'll be forced to sell at the bottom when you should be buying more. All these systems seem easy, but when you actually get in there and try to use them, you'll find they're not so easy.  Anything that is obvious, won't work anymore.  And even when you find something that is obvious and bet that it stops working, you'll be wrong then too.  The thing is, if you think of it, many others just like you also think of it... therefore it can't work because everyone can't make money in stocks just like everyone at the poker table can't make money.  If you can make 1% or 2% per day on your money, that's actually quite good and not too many people can do that.  Or maybe its better to say, if you can make 2% per trade, and not take a 50% loss per 10 trades, you're doing quite well. If you make $40 per trade profit while working with $2-3k and you do that 50 times per year (50 trades is not a lot in a year), you've doubled your money for the year.  Who does that on a consistent basis?  To expect that kind of performance is just unrealistic.  It much easier to earn $2k with $100k than it is to double $2k in a year.  In stocks, money flows TO those who have it and FROM those who don't. You have to plan for all possibilities, form a system then stick to it, and not take on too much risk or expect big (unrealistic) rewards. Daytrading You make 4 roundtrips in 5 days, that broker labels you a pattern daytrader.  Once you're labeled, its for life at that brokerage.  If you switch to a new broker, the new broker doesn't know your dealings with the old broker, therefore you'll have to establish a new pattern with the new broker in order to be labeled.  If the SEC were to ask, the broker would have to say 'yes' or 'no' concering if you established a pattern of daytrading at that brokerage. Suppose you make the 4 roundtrips and then you make a 5th that triggers the call.  The broker will call you up and say you either need to deposit enough to bring your account to $25k or you need to never make another daytrade at that firm... ever!  That's the only warning you'll ever get.  If you're in violation again, they lock your account to closing positions until you send in funds to bring the balance up to $25k.  All you need to do is have the money hit your account, you can take it right back out again.  Once your account has $25k, you're allowed to trade again.... even if you remove $15k of it that same day.  If you trigger the call again, you have to send the $15k back in, then take it back out. Having the label is not all bad... they give you 4x margin.  So with $25k, you can buy $100k of marginable stock.  I don't know... that could be a bad thing too.  You could get a margin call at the end of the day for owning $100k of stock when you're only allowed to own $50k overnight.  I believe that's a fed call and its a pretty big deal. One difference is the bid/ask spread will cost you more in a lower cost stock than a higher cost one. Say you have two highly liquid stocks with tiny spreads: If you wanted to buy say $2,000 of stock: Now imagine these are almost identical ETFs tracking the S&P 500 index and extrapolate this to a trade of $2,000,000 and you can see there's some cost savings in the higher priced stock. As a practical example, recently a popular S&P 500 ETF (Vanguard's VOO) did a reverse split to help investors minimize this oft-missed cost. An index fund is inherently diversified across its index -- no one stock will either make or break the results. In that case it's a matter of picking the index(es) you want to put the money into. ETFs do permit smaller initial purchases, which would let you do a reasonable mix of sectors. (That seems to be the one advantage of ETFs over traditional funds...?) In market cap weighted index there is fairly heavy concentration in the largest stocks. The top 10 stocks typically account for about 20% of the S&P 500 index.  In Equal Weight this bias towards large caps is removed. The Market Cap method would be good when large stocks drive the markets. However if the markets are getting driven by Mid Caps and Small caps, the equal weight wins. Historically most big companies start out small and grow big fast in a short span of time. Thus if we were to do Market cap one would have purchased smaller number of shares of the said company as its cap/weight would have been small and when it becomes big we would have purchased the shares at a higher price. However if we were to do equal weight, then as the company grows big one would have more share at a cheaper price and would result in better returns. There is a nice article on this, also gives the comparision of the returns over a period of 10 years, where equal weight index has done good. It does not mean that it would continue. http://www.investopedia.com/articles/exchangetradedfunds/08/index-debate.asp#axzz1RRDCnFre To a certain extent, small cap companies will in general follow the same trends as large cap companies. The extent of this cointegration depends on numerous factors, but a prime reason is the presence of systemic risk, i.e. the risk to the entire market. In simple terms, sthis is the risk that your portfolio will approach asymptotically as you increase its diversification, and it's why hedging is also important.  That being said, small cap businesses will, in general, likely do worse than large cap stocks, for several reasons. This was/is certainly the case in the Great Recession.  Small cap businesses have, on average, higher betas, which is a measure of a company's risk compared to the overall market. This means that small cap companies, on average outperform large cap companies during boom times, but it also means that they suffer more on average during bear times. The debate over whether or not the standard beta is still useful for small cap companies continues, however. Some economists feel that small cap companies are better measured against the Russell 2000 or similar indexes instead of the S&P 500.  Small cap companies may face problems accessing or maintaining access to lines of credit. During the Great Recession, major lenders decreased their lending to small businesses, which might make it harder for them to weather the storm.  On a related point, small businesses might not have as large an asset base to use as collateral for loans in bad times. One notable large cap company that used its asset base to their advantage was Ford, which gave banks partial ownership of its factories during hard times. This a) gave Ford a good amount of cash with which to continue their short-term operations, and b) gave the banks a vested interest in keeping Ford's lines of credit open. Ford struggled, but it never faced the financial problems of GM and Chrysler.  Despite political rhetoric about Main Street vs. Wall Street, small businesses don't receive as much government aid in times of crisis as some large cap companies do. For example, the Small Business Lending Fund, a brilliant but poorly implemented idea in 2010, allocated less than $30 billion to small businesses. (The actual amount loaned was considerably less). Compare that to the amounts loaned out under TARP. Discussions about corporate lobbying power aside, small businesses aren't as crucial to the overall stability of the financial system Small businesses don't always have the manpower to keep up with changes in regulation. When the Dodd-Frank Act passed, large banks (as an example), could hire more staff to understand it and adapt to it relatively easily; small banks, however, don't always have the resources to invest in such efforts.  There are other reasons, some of which are industry-specific, but these are some of the basic ones.  If you want visual confirmation that small cap businesses follow a similar trend, here is a graph of the Russell 2000 and S&P 500 indexes:  Here is a similar graph for the Russell 2000 and the Dow Jones Industrial Average.   If you wanted to confirm this technically and control for the numerous complicated factors (overlap between indexes, systemic risk, seasonal adjustment, etc.), just ask and I'll try to run some numbers on it when I have a chance. Keep in mind, too, that looking at a pretty picture is no substitute for rigorous financial econometrics. A basic start would be to look at the correlation between the indexes, which I calculate as 0.9133 and 0.9526, respectively. As you can see, they're pretty close. Once again, however, the reality is more complicated technically, and a sufficiently detailed analysis is beyond my capabilities. Just a quick side note. These graphs show the logarithm of the values of the indexes, which is a common statistical nuance that is used when comparing time series with radically different magnitudes but similar trends.  S&P500 and Russell 2000 data came from Yahoo! Finance, and the Dow Jones Industrial Average data came from Federal Reserve Economic Data (FRED) Per usual, I try to provide code whenever possible, if I used it. Here is the Stata code I used to generate the graphs above. This code assumes the presence of russell2000.csv and sp500.csv, downloaded from Yahoo! Finance, and DJIA.csv, downloaded from FRED, in the current directory.  Fidelity published an article  on the subject that you might find interesting, and Seeking Alpha has several pieces related to small-cap vs. large-cap returns that might be worth a read too. "As Dheer pointed out, the top ten mega-cap corporations account for a huge part (20%) of your ""S&P 500"" portfolio when weighted proportionally. This is one of the reasons why I have personally avoided the index-fund/etf craze -- I don't really need another mechanism to buy ExxonMobil, IBM and Wal-Mart on my behalf. I like the equal-weight concept -- if I'm investing in a broad sector (Large Cap companies), I want diversification across the entire sector and avoid concentration. The downside to this approach is that there will be more portfolio turnover (and expense), since you're holding more shares of the lower tranches of the index where companies are more apt to churn. (ie. #500 on the index gets replaced by an up and comer). So you're likely to have a higher expense ratio, which matters to many folks." OK, VERY glad you get that idea!  The problem with the ETF is: it's the monkeys-throwing-darts method. If the average (dollar-weighted) member stock in the ETF goes up, you win, but if half of them go under, and half succeed, over some time periods you will lose (and win over others).  I guess my POV is: if you can't do serious research into the expected success of an individual company, maybe it's too risky to even try betting on the whole group. YMMV. The problem with your investment plan is: you are depending on luck, and the assumption the group will increase in value over your investment period. I prefer research over hope. Small cap and mid cap shares tend to outperform large cap shares in a bull market, but they tend to underperform large cap shares in a bear market. Since the stock markets tend to go up in the long term, this suggests that a low cost small and mid cap index ETF should offer the best long term returns.   Having said that, we are currently in a mature bull market having experienced over seven years without encountering a bear market.  If a bearish outlook is something you worry about, then perhaps a broad market index, which will be heavily weighted towards large cap shares, may be a better choice for you at this time, with an eye toward switching to small and mid cap indices during the next bear market. If you are looking at long-term investments then you can look to Dheer's answer and see that it doesn't matter whether the money is large or small, the return will be the same.  When it comes to shorter-term investments, it can actually pay to be a smaller investor. Consider a stock that may not be trading in high volume. If I want to take a position for 2,000 shares, I can probably buy it quite quickly without moving the market considerably.  If I was managing your hypothetical portfolio opening a position for 1,000,000 shares, it can cause the price to go up significantly because I have to execute the order very carefully in order to not tip my hand to the market that I want a million shares.  Algorithmic traders will see the volume increasing on those shares and will raise their asking price. High speed traders and market makers will also cause a lot of purchasing overhead. Then later when it comes time to sell, I will lose a percentage to the price drop as I start flooding the market with available shares. To add to Dheer's point, the vast majority of retail investors will have to pay fees and use up a large amount of valuable time on the entrance and exit of each stock, and each and every time you rebalance as the index weightings change. These also add up extremely fast vs the few basis points the large and liquid ETFs charge for this service. "The problem with daily-rebalanced ""inverse"" or ""leveraged"" ETFs is that since they rebalance every day, you can lose money even if your guess as to the market's direction is correct. Quoting from FINRA'S guide as to why these are a bad idea: How can this apparent breakdown between longer term index returns and ETF returns happen? Here’s a hypothetical example: let’s say that on Day 1, an index starts with a value of 100 and a leveraged ETF that seeks to double the return of the index starts at $100. If the index drops by 10 points on Day 1, it has a 10 percent loss and a resulting value of 90. Assuming it achieved its stated objective, the leveraged ETF would therefore drop 20 percent on that day and have an ending value of $80. On Day 2, if the index rises 10 percent, the index value increases to 99. For the ETF, its value for Day 2 would rise by 20 percent, which means the ETF would have a value of $96. On both days, the leveraged ETF did exactly what it was supposed to do—it produced daily returns that were two times the daily index returns. But let’s look at the results over the 2 day period: the index lost 1 percent (it fell from 100 to 99) while the 2x leveraged ETF lost 4 percent (it fell from $100 to $96). That means that over the two day period, the ETF's negative returns were 4 times as much as the two-day return of the index instead of 2 times the return. That example is for ""just"" leveraging 2x in the same direction. Inverse funds have the same kind of issue. An example from Bogleheads Wiki page on these kinds of funds says that over 12/31/2007 to 12/31/2010, The funds do exactly what they say on any given day. But any losses get ""locked in"" each day. While normally a 50% loss needs a 100% gain to get back to a starting point, a fund like this needs more than a 100% gain to get back to its starting point. The result of these funds across multiple days doesn't match the index it's matching over those several days, and you won't make money over the long term. Do look at the further examples at the links I've referenced above, or do your own research into the performance of these funds during time periods both when the market is going up and going down. Also refer to these related and/or duplicate questions:"