US Small Caps to Outperform Large Caps for Next Decade, Vanguard Says

Vanguard forecasts U.S. small-cap equities to generate annualized returns of 5.8% to 7.8% over the next ten years. This exceeds the firm's projected 4.8% to 6.8% returns for U.S. large-cap stocks. The forecast suggests a structural rotation in U.S. equity markets is underway.

For much of the past 15 years, large-cap growth stocks—primarily major technology companies—have dominated portfolio returns. That trend now faces headwinds from shifting fundamentals. Recent Fidelity research points to small-cap stocks demonstrating stronger earnings growth alongside cheap valuations. Vanguard’s own projections add to this thesis, forecasting that U.S. value stocks will outperform growth equities over the coming decade.

The shift is already being priced into the market. Both the iShares Russell 2000 ETF (IWM) and the Vanguard Small-Cap Value ETF (VBR) have outpaced the benchmark S&P 500 index and the tech-heavy Nasdaq-100 index year to date. For investors constructing long-term portfolios, these funds represent the primary vehicles to capture the anticipated small-cap premium.

The IWM offers a broad-market approach. Holding 1,974 stocks, the fund tracks the Russell 2000 index. Since its inception in May 2000, it has delivered annualized returns of 8.7%. Recent momentum has been strong, with the fund returning 18% over the past three years and approximately 41% over the past twelve months. It carries an expense ratio of 0.19%.

For investors seeking to combine the small-cap outlook with the value factor, the VBR presents a targeted option. The fund holds 840 stocks, focusing strictly on value-oriented small-cap companies. This narrower mandate has resulted in marginally better long-term performance, with the VBR posting a 9.51% annualized return over its 26-year history. For market participants aligning with Vanguard’s value forecast, the VBR offers a dual-factor approach as the large-cap growth trade cools.