Are you looking to expand your investment portfolio and tap into the growth potential of small-cap companies around the globe? Investing in small-cap world ETFs can be a strategic move. These ETFs offer diversification across numerous countries and sectors, allowing you to participate in the growth of emerging and established markets without the need to pick individual stocks. But with so many options available, choosing the right ETF can be daunting. This guide will walk you through the key considerations and highlight some top-performing small-cap world ETFs to help you make an informed decision.

Understanding Small-Cap World ETFs

Small-cap world ETFs are exchange-traded funds that invest in small-sized companies located in various countries around the world. These companies typically have market capitalizations ranging from a few hundred million to a few billion dollars. Investing in these ETFs allows you to gain exposure to a broad range of international markets, including developed, emerging, and frontier markets. The main advantage of investing in a small-cap world ETF is diversification. By holding a single fund, you can spread your investment across hundreds or even thousands of small-cap companies, reducing the risk associated with investing in individual stocks. Additionally, these ETFs provide access to markets and companies that might be difficult or costly to invest in directly. Furthermore, small-cap companies often have higher growth potential compared to larger, more established companies. They may be more innovative, agile, and capable of adapting to changing market conditions. By including small-cap world ETFs in your portfolio, you can potentially benefit from this higher growth potential. However, it's important to note that small-cap companies are also generally more volatile than large-cap companies, and their stock prices can fluctuate more significantly. Therefore, it's crucial to carefully consider your risk tolerance and investment goals before investing in these ETFs.

Key Considerations When Choosing an ETF

When selecting a small-cap world ETF, there are several factors you should consider to ensure the ETF aligns with your investment objectives and risk tolerance. Let's explore these key considerations in detail.

Expense Ratio

The expense ratio is the annual fee charged by the ETF to cover its operating expenses. This fee is expressed as a percentage of the assets under management (AUM). Lower expense ratios are generally preferable, as they reduce the overall cost of investing in the ETF. Even seemingly small differences in expense ratios can have a significant impact on your long-term returns. For example, an ETF with an expense ratio of 0.20% will cost you $20 per year for every $10,000 invested, while an ETF with an expense ratio of 0.50% will cost you $50 per year for every $10,000 invested. Over several years, this difference can add up to a substantial amount. When evaluating small-cap world ETFs, compare the expense ratios of different funds and choose the one with the lowest cost, all other factors being equal. Keep in mind, however, that the expense ratio is not the only factor to consider. You should also look at other factors such as tracking error, liquidity, and the ETF's investment strategy.

Tracking Error

Tracking error measures how closely the ETF's performance matches the performance of its underlying index. A lower tracking error indicates that the ETF is effectively replicating the index's returns. Tracking error can arise due to various factors, such as the ETF's expense ratio, transaction costs, and the ETF manager's investment decisions. Some ETFs may use sampling techniques, where they only hold a representative sample of the securities in the index, rather than holding all of them. This can also contribute to tracking error. When evaluating small-cap world ETFs, look for funds with low tracking error, as this indicates that the ETF is accurately reflecting the performance of the small-cap world market. You can find information on an ETF's tracking error in its prospectus or on financial websites that provide ETF data. Keep in mind that some tracking error is inevitable, but you should aim to choose an ETF with a tracking error that is as low as possible.

Liquidity

Liquidity refers to the ease with which you can buy or sell shares of the ETF without significantly impacting its price. Highly liquid ETFs have tight bid-ask spreads and large trading volumes, making it easier to execute trades quickly and efficiently. Liquidity is particularly important for investors who may need to buy or sell shares of the ETF frequently or in large quantities. Illiquid ETFs can have wider bid-ask spreads, which can increase your transaction costs and reduce your overall returns. To assess the liquidity of a small-cap world ETF, look at its average daily trading volume and its bid-ask spread. Higher trading volumes and narrower bid-ask spreads indicate greater liquidity. You can find this information on financial websites or from your brokerage platform. Also, consider the size of the ETF's assets under management (AUM). Larger ETFs tend to be more liquid than smaller ETFs.

Index and Investment Strategy

The index that the ETF tracks and its investment strategy are crucial factors to consider. Understand which index the ETF is designed to replicate and the criteria used to select and weight the stocks within that index. Some small-cap world indexes may have a greater emphasis on certain regions or sectors, which can impact the ETF's performance. Additionally, consider the ETF's investment strategy. Some ETFs may use a passive investment strategy, where they simply aim to replicate the performance of the index. Others may use an active investment strategy, where the ETF manager actively selects and weights stocks in an attempt to outperform the index. Actively managed ETFs typically have higher expense ratios than passively managed ETFs. When evaluating small-cap world ETFs, carefully review the ETF's index and investment strategy to ensure they align with your investment goals and risk tolerance. Consider whether you prefer a passive approach that simply tracks the index, or an active approach that seeks to generate higher returns. Also, pay attention to the index's methodology and its exposure to different regions and sectors.

Top Small-Cap World ETFs

Based on the considerations discussed above, here are a few top small-cap world ETFs that stand out in the market:

1. Vanguard FTSE All-World ex-US Small-Cap ETF (VSS): This ETF tracks the FTSE All-World ex US Small Cap Index, providing broad exposure to small-cap companies in developed and emerging markets, excluding the United States. VSS is known for its low expense ratio and high liquidity, making it a popular choice among investors.
2. iShares MSCI EAFE Small-Cap ETF (SCZ): This ETF tracks the MSCI EAFE Small Cap Index, which focuses on small-cap companies in developed markets, excluding the United States and Canada. SCZ offers a diversified portfolio of small-cap stocks in Europe, Australasia, and the Far East.
3. SPDR Portfolio Developed World ex-US Small Cap ETF (GWX): This ETF tracks the S&P Developed Ex-U.S. Under USD6 Billion Index, offering exposure to small-cap companies in developed markets outside the United States. GWX is another low-cost option that provides broad diversification.

Integrating Small-Cap World ETFs into Your Portfolio

Once you've chosen the right small-cap world ETF, it's important to integrate it strategically into your overall investment portfolio. Consider the following tips:

• Determine Your Allocation: Decide what percentage of your portfolio you want to allocate to small-cap world ETFs. This will depend on your risk tolerance, investment goals, and time horizon. A general guideline is to allocate a higher percentage to small-cap world ETFs if you have a longer time horizon and a higher risk tolerance.
• Rebalance Regularly: Periodically rebalance your portfolio to maintain your desired asset allocation. This involves selling some assets that have increased in value and buying assets that have decreased in value. Rebalancing helps to ensure that your portfolio remains aligned with your investment goals and risk tolerance.
• Consider Tax Implications: Be aware of the tax implications of investing in small-cap world ETFs. Dividends and capital gains from these ETFs may be subject to taxes. Consult with a tax advisor to understand the tax consequences of your investment decisions.

Conclusion

Small-cap world ETFs can be a valuable addition to your investment portfolio, providing diversification and exposure to the growth potential of small-cap companies around the globe. By carefully considering factors such as expense ratio, tracking error, liquidity, and index, you can choose the right ETF to meet your investment objectives. Remember to integrate small-cap world ETFs strategically into your portfolio and rebalance regularly to maintain your desired asset allocation. With the right approach, you can potentially enhance your portfolio's returns and achieve your long-term financial goals. So, go ahead and explore the world of small-cap ETFs and unlock the opportunities they offer for global diversification and growth.