Small caps have enjoyed a comeback in 2026. Granted, some of the volatility we’ve seen in March has made it a bit of a wild ride, but small caps are still outperforming large caps by about 4% for the year so far (as of March 10).
Given how long small caps have underperformed the S&P 500(SNPINDEX: ^GSPC), it’s reasonable to think that they might finally be due for an extended run. An improved earnings outlook plus attractive valuations provide a nice setup as long as the current economic expansion doesn’t get derailed.
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Of more than 100 exchange-traded funds (ETFs) in this category, the majority have the words “small cap” in them. There’s the Vanguard Small Cap ETF, the Schwab U.S. Small Cap ETF, and the Dimensional U.S. Small Cap ETF. It’d be easy to think that based on their naming conventions they’re very similar and therefore interchangeable. That may be true, but in many cases it isn’t.
There are two heavyweights in this category: the iShares Russell 2000 ETF(NYSEMKT: IWM) and the iShares Core S&P Small Cap ETF(NYSEMKT: IJR). This is a good example of why it’s so important to look past just the name to really understand what you’re buying. When it comes to these two well-known small-cap ETFs, you’re owning two very different portfolios.
Image source: Getty Images.
The big difference between these two ETFs is in the index that they track.
As the name suggests, the iShares Russell 2000 ETF tracks the Russell 2000 index. It doesn’t do a whole lot of targeting. It simply includes the 2,000 biggest stocks after the Russell 1000 Large Cap index.
The iShares Core S&P Small Cap ETF tracks the S&P 600 index. It’s basically the 600 stocks after the S&P 500 and S&P 400 Mid Cap indexes have been filled out.
So you have a major difference between how many stocks are in the respective indexes and the size of those companies right off the bat. But the distinctions go far beyond that.
If you simply want to own the entire small-cap universe and everything that comes with it, the iShares Russell 2000 ETF is probably for you.
Outside of a few basic liquidity and tradability screens, it essentially just takes the entire basket of 2,000 stocks and puts it in the index. The biggest red flag that comes from taking this approach is that you get a lot of junk with the good. I’ve noted several times before that approximately 40% of Russell 2000 components are currently unprofitable.
That may not be as big of an issue if the market is in a risk-on mood and more speculative companies are getting rewarded. But it can be a real problem if the economy slows, earnings come in below expectations, or there’s any event really that ratchets up volatility and investors’ nerves.
The S&P 600 index solves a lot of those problems. To qualify for the index, a company must have positive earnings in its most recent quarter and positive earnings over the past four quarters collectively.
That means the iShares Core S&P Small Cap ETF’s portfolio has better margins, return on equity, and return on assets compared to the iShares Russell 2000 ETF. In a segment of the market like small caps where so many companies are carrying heavy debt loads and struggling to become successful, having an ETF option that focuses only on the current winners can make a big difference.
When investing in small caps, I prefer the quality option with the iShares Core S&P Small Cap ETF.
I’m not as worried about investing only in profitable companies when it comes to large caps and mid caps. The vast majority of companies in those two universes are already profitable, so it doesn’t make a big difference.
In small-cap investing, it does. I’d rather avoid the unprofitable names in that universe at the risk of missing out on some upside in a bull market. I prefer instead to try to limit downside risk by going with the quality tilt.
Putting these two ETFs side by side emphasizes one thing that should always be done regardless of which funds you’re examining: Always look under the hood to understand what you’re buying.
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David Dierking has positions in Schwab Strategic Trust-Schwab U.s. Small-Cap ETF. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Small-Cap ETF and iShares Core S&P Small-Cap ETF. The Motley Fool has a disclosure policy.
