Many investors think that because they own a dozen blue-chip stocks or shares in a Standard & Poor’s 500index fund that they have a well-balanced stake in the U.S. stock market. But actually, they don’t. 

That’s because big companies, even 500 of them, make up less than a 10th of the number of publicly traded U.S. stocks. Enter the Russell 2000 Index, a benchmark made up of 2,000 U.S. companies not likely to be included in the S&P 500. The Russell 2000 “gives you diversification and, as they say, diversification is the only free lunch,” says Titan strategist Myles Udland.

What is the Russell 2000?

The Russell 2000 is an index created in 1984 to track the performance of 2,000 small companies as measured by their market value. It is managed by FTSE Russell, a subsidiary of the London Stock Exchange. 

To decide which stocks qualify for the benchmark,  FTSE Russell first ranks 3,000 companies by stock market capitalization—or share price multiplied by the number of shares outstanding—and slices off 2,000 of the smallest to create the Russell 2000.

Each year, in June, FTSE Russell reconstitutes the index, adding new companies, and tossing out those that have gotten too big or otherwise no longer qualify.

Potential benefits and risks of investing in the Russell 2000

Below are some of potential upsides and downsides of the Russell 2000:

• Performance

  : During bull markets, the Russell 2000 tends to underperform. For example,  in 2021, a time generally considered a bull market, the S&P 500 trounced the Russell 2000, gaining 29% to 12% for the small-cap index.

• Volatility

  : Small-cap stocks are seen as riskier investments and as a result, indexes like the Russell 2000 tend to be more volatile than their large-cap counterparts. As measured by standard deviation, which is the degree by which the Russell 2000’s price varies around its mean over time, the small cap index is roughly 25% more volatile than the S&P 500. 

• Diversification

  : The Russell 2000 offers more diversification across a range of industries versus the S&P 500, which is dominated by tech companies. But because it’s made up of small companies, many without international operations, the Russell 2000 is more dependent on the U.S. economy than the S&P 500. Companies in the large-cap index recently earned about 40% of their sales from abroad, giving investors more diversification through exposure to the global economy.

• Valuation

  : Because the companies in the Russell are deemed to be risker, the index often trades at a discount to the larger-cap benchmark, as measured by the price of its shares compared to the earnings they generate, or the price-to-earnings ratio (P/E). As of March 2022, the P/E of the Russell 2000 was 13.7 versus 19.8 for the S&P 500.

How to invest in the Russell 2000

Investors can’t invest directly in an index, so those who want exposure to the Russell 2000 will need to invest either in an indexed mutual fund or exchange-traded fund (ETF). 

Some prominent mutual funds that seek to track the index include:

• MM Russell 2000 Small Cap Index
• Rydex Russell 2000 
• Schwab Small Cap Index
• Voya Russell Small Cap Index Portfolio
• iShares Russell 2000 Small-Cap Index

The three biggest Russell 2000 ETFs are:

• iShares Russell 2000 ETF
• Vanguard Russell 2000 ETF
• Direxion Daily Small Cap Bull 3X Shares

Many ETFs that track the index have special features, however, seeking to use leverage to magnify the index’s gains or losses.

Fees range from 0.04% of assets in the Schwab Small-Cap Index Fund’s to a steep 1.67% at Fidelity’s Rydex Russell 2000 A shares. 

What to consider when investing in the Russell 2000

Investors weigh a variety of factors when deciding how much of their assets, if any, to invest in the Russell 2000. 

• Selection bias

  : Because of the rules used to select stocks, the index probably won’t capture the performance of large, hot companies. Companies that grow too big fast graduate to larger cap indexes, making room for smaller members. For example, Amazon.com and Netflix graduated in 1998 and 2009, respectively.

• Tracking error

  : The Russell 2000 is made up of many small stocks, some of which can be difficult to trade. For this reason, a Russell 2000 index fund portfolio manager may have more difficulty  tracking the index than an S&P 500 fund manager, because stocks in the large-cap index are more liquid and easier to buy and sell. This can lead to what’s known as tracking error, or deviation from the performance of the index being tracked.‍

• Alternatives

  : Investors who want exposure to small stocks have other small-cap indexes to choose from, such as the Standard & Poor’s SmallCap 600 Index and the Dow Jones U.S. Small Cap Total Stock Market Index. They use different methodologies to select member companies and hence their constituents, weightings and performance varies.

Top 10 Russell 2000 holdings by market value

In contrast to the S&P 500, which is heavily weighted by big, well-known tech companies, the Russell 2000 offers greater industry diversification. As of March 2022, the 10 biggest companies by market cap are:

• Ovintiv, an oil and gas producer
• AMC Entertainment, a movie theater chain
• Synaptics, a semiconductor maker
• Tenet Healthcare, a hospital operator 
• BJ’s Wholesale Club, a retailer
• Tetra Tech, an engineering firm
• Lattice Semiconductor, a circuitmaker
• Performance Food Group, a food-services distributor
• Macy’s, the department store chain
• Chesapeake Energy, an exploration and oil producer
  

FAQ about the Russell 2000

Below are some of the questions an investor might have about the index.

What’s the difference between the Russell 2000 and the Russell 1000?

There are a number of other FTSE Russell indexes and they fit together somewhat like the pieces of a puzzle. When FTSE Russell considers which companies to include in its indexes, it first narrows down the universe to 3,000 stocks. The biggest 1,000 are carved off to form the  Russell 1000 Index, made up of the largest 1,000 U.S. stocks by market capitalization. The remaining 2,000 form the Russell 2000. The two benchmarks account for the majority of U.S. stocks. 

What is the average return of the Russell 2000?

The Russell 2000’s annualized returns were 10.5%, 9.5% and 11.2% during the three, five and 10-year periods ended February 2022. 

Because this was a period that favored large-cap stocks—particularly big tech companies—the Russell 2000 underperformed the Russell 1000, which had annualized returns of 18.1%, 15.1%, 14.5% for the same time periods.

Is the Russell 2000 a good investment?

“Different” might be a better way to describe the Russell 2000. In terms of performance, there are times when it can do well, others when it lags. For example, from Jan. 1, 2003, to Jan. 1, 2007, the period before the 2007-09 financial crisis, the index rose 117% while the S&P 500 gained 68%. But from Jan. 31, 2009, to Feb. 28, 2022, a time when the big tech companies that dominate the S&P 500 were on a tear, the large-cap index rose 461% to 362% for the Russell 2000. 

The bottom line

The Russell 2000 reflects the performance of 2,000 publicly traded small-cap companies, many of which are not well-known by the general public. Investors often turn to it to balance their investments in a large-cap stock index like the S&P 500. Investors can’t directly invest in the index, but there are a number of index mutual funds and ETFs that make it easy to capture the Russell 2000’s performance.