Let me ask you a question…

If I handed you a lump sum of cash right now to invest for your retirement, how would you spend it?

No, it’s not a trick question. And there are several different good answers.

If you’re looking for something low maintenance, maybe you’d put that money into an ETF or mutual fund…

Or if you’re a little more proactive, maybe there are a few dividend-paying stocks you’d like to invest that cash into…

Or maybe you’re more risk-averse, so you’d rather take advantage of today’s high yield on Treasury bonds.

Whatever you decide, I bet small-cap stocks probably weren’t your first answer. But today I’ll show you why they deserve your attention.

Before I do, let’s first look at how these stocks fell out of favor in the first place.

Why I'm Betting Big on Small Stocks

Small caps took a beating last year as volatility rocked Wall Street and investors flocked to the perceived stability of mega-cap tech stocks.

In 2022, the Russell 2000 small-cap index fell over 20%. This basket of stocks began to recover earlier this year but plummeted again in the summer.

By the end of October, the index had essentially given back all of the gains it made in three years.

There are a few key reasons why small-cap stocks underperformed over the past few years.

First, with worries about recession and inflation dominating headlines, traders pivoted heavily towards "safety trades" like Apple, Microsoft and Google's parent Alphabet.

These mega-cap tech titans benefited from their robust balance sheets and billions in cash reserves to weather any storm.

Smaller companies with much less reliable businesses, however, were viewed as higher risk.

Second, institutional investment dollars focused increasingly on the largest stocks.

With trillions in assets, pension funds and other big institutional investors struggle to efficiently allocate capital into shares with lower liquidity.

So despite mouth-watering valuations, small caps were starved of buying interest.

And finally, algorithmic trading funds and their laser focus on momentum added fuel to the rush toward mega-caps.

As large tech stocks became a crowded trade, computers perpetuated the herd mentality. So smaller, cheap stocks with strong fundamentals were largely ignored.

But this paradigm has begun to shift.

Small caps have staged an impressive rebound this month. And small-cap funds have received strong inflows in November, as you can see in the chart below.

Source: The Daily Shot

Demand for call options on the Russell 2000 index has also surged, meaning speculative investors are now betting on a rebound for this basket of stocks.

Admittedly, we haven’t covered small-cap stocks here at Rich Retirement Letter in quite a while.

Part of that’s because we tend to focus on blue-chip stocks that offer long-term income growth. And it’s partly because small caps have carried far too much risk lately.

But given the changing landscape for small-caps, it’s time to reevaluate the power behind small stocks in your investment account.

Small Stocks Offer Oversized Returns

Unlike mega caps that already dominate their industries, small companies have much more room for expansion.

A promising new product or service can propel rapid growth for a small firm, while barely moving the needle for a behemoth like Google.

Small caps are nimble and can adapt quickly to seize new opportunities. And many are pioneering cutting-edge technologies before they hit the mainstream.

Investing in these stocks early allows us to ride the wave as they disrupt industries and grow into market leaders.

Of course, individuals aren’t the only ones interested in buying small companies for their growth opportunities. That brings me to my next point…

Large companies are always looking to expand their capabilities by acquiring smaller firms.

With ample cash reserves and limited growth options, mega-caps often find it easier to purchase innovation rather than develop it themselves.

So small caps are prime acquisition targets. Buying shares ahead of a buyout can deliver overnight windfalls.

Even rumors of potential deals can rapidly boost stock prices, regardless of whether a buyout deal materializes.

And on a similar note, small-cap stocks can rise in price from large buy orders from institutional investors. Think about it this way…

If an institution wants to invest $10 million into Alphabet, it doesn't affect the stock price, because it’s such a large and liquid stock.

But if an institution wants to invest $10 million into a small company, that buy order will naturally drive the price higher.

Sometimes this process takes weeks while the institutions slowly build a position, driving prices higher over time.

If you’ve avoided small-cap stocks up until now (and I can’t blame you), let this serve as your wake-up call.

It’s time to get exposure to this overlooked area now before other investors catch on.