Performance among investors, institutions, endowments, and retirement plans is often compared on a relative basis: what returns were available to me and did I capture them as well as the index and/or some other guy? And while this can be a useful tool for someone who is investing in a manner that may be detrimental to themselves or their constituents, it often creates a guise of what’s called hindsight bias: “I should have known that was coming…it was so glaringly obvious.” Hindsight bias creates an illusion that what happened had to happen, which is rarely true in a probabilistic world driven by outliers.
Take, for example, a weather forecast of, “90% chance of sunny and 75 degrees” and the takeaway that tomorrow will be a great day to go for a hike. You get out there and about halfway in, there’s a downpour of epic proportions. It lasts 40 minutes and after, it starts to get sunny again, but that’s no solace, everyone in your group is soaked and disappointed: “that weatherman is no good.” Understanding how probabilities play out in the world is one of the most difficult concepts for the human mind to comprehend. Likely because we assign much of the credit for our successes to ourselves and much of the blame for our failures to outside influences. Even so, the idea that the most likely outcome did not occur is met with “so what?” And the idea that what happened did not have to happen is so obvious that its profoundness is often disregarded as irrelevant. Keep this idea of hindsight in your back pocket.
Small Caps, Big Differences
Taking this back into the investment realm, two themes dominate today’s market conversations: the astronomical rise of the Magnificent 7 and the push among advisors toward alternatives. It isn’t hard to see why. Those seven companies have delivered exceptional returns in recent years, and after 2022, when stocks and bonds fell together, the “death of the 60/40” resurfaced for what feels like the twentieth time in a decade.
Layered on top of this are the familiar explanations offered for why small cap stocks have trailed large caps: companies are staying private longer, too many small caps are unprofitable, the category doesn’t have enough technology exposure, and so on. Each story is packaged with a solution to shift the allocation to…guess what…a product offered by the person telling the story! Yet in all the narrative-building, very few people pause to ask the simpler question: is there actually something wrong with small cap performance? Hm…
US small caps earned a return over the last 10 years that came in just under one percentage point from their long-term average. Large caps, in contrast, delivered returns nearly 50% higher than their own historical norm. Investors have benefited enormously from the extraordinary growth of the Magnificent 7 companies. When firms produce earnings far above expectations, returns can be far above expectations as well. Diversified investors have enjoyed that surprise.
So, yes, if I could go back in time and own only one asset class over the last 10 years, it would not be US small caps nor US large caps. It would be Bitcoin (~79.6% CAGR over the last 10 years). But how useful is that?
Identical Twins: The Last Decade and the Next Decade?
If anything, the last decade tells us less about the structural state of small-cap stocks and more about the danger of extrapolating an exceptional period into the future. The hindsight noise tends to distract us from the reality that every relative comparison is anchored to an arbitrary timeframe. Ten years is long enough to feel like a permanent state of the world, but short enough to be thoroughly shaped by unique events: zero-interest-rate policy, a once-in-a-century pandemic, unprecedented fiscal stimulus, and the emergence of a concentrated group of firms with world-changing business models. This past decade was indeed different, just like the decade before it, and the decade before that.
And this can become problematic when yesterday’s surprise becomes tomorrow’s assumption. Expecting large caps to repeat a decade of far-above-average returns requires assuming that the companies already exceeding expectations will keep doing so at the same pace. That may happen, but it seems unreasonable for investors to count on as a baseline.
Many observers have spent years trying to craft a narrative to explain why small caps “haven’t worked.” Yet the data suggests something simpler. Small caps have behaved very much in line with their long-run history. Large caps have been the outlier. There is nothing wrong with celebrating the strong results that large companies have delivered, and nothing wrong with acknowledging that those results do not define what the next decade must look like.
A diversified investor benefits when different parts of the market shine at different times. Over the last ten years, large caps happened to shine the brightest. And many are happy to have owned them. But don’t forget that small caps delivered a part of the bargain as well. The future will have its own surprises, and the leaders of the next decade may not look like the leaders of the last.
CONSIDER
Three ideas for company-building:
- “Everyone in life walks around with an invisible sign around their neck that says “make me feel important.”” – Mary Kay
- “At the end of the day, a company is just a collection of people solving problems, one after the next, and they keep getting bigger [the problems]. The question is: how much can you endure and for how long? And the best way to do that is with resilient, talented people who are very aligned.” Karin Atiyeh
- “The best jobs are neither decreed nor degrees, they are creative expressions by continuous learners in free markets.” – Naval Ravikant
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Let’s get after it this week!
Brooks
Brooks Palmer, CFP® is Head of Investments at Root where he helps identify, evaluate, and implement investment solutions tailored to clients’ needs. In Full-Court Press, he breaks down what’s happening in the markets—cutting through the noise and jargon—while connecting it to Root’s core investment tenets so you can make the most of your money and your life!
Past performance is not a guarantee of future results. Actual returns may be lower. Data is as of 10/31/25. S&P data © 2025 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. The Fama/French US Small Cap Research Index represents an academic index that is not available for direct investment or for use as a benchmark. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment.
Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The examples provided are hypothetical and for illustrative purposes only. The information presented should not be construed as investment advice or a recommendation to buy or sell any security or implement a particular strategy.
Advisory services are offered through Root Financial Partners, LLC, an SEC registered investment adviser.
