Is a Small-Cap ETF the Best Investment of 2026? Here's What the Data Suggests.

Amid the dominance of artificial intelligence (AI) stocks and the "Magnificent Seven" of the past few years, many investors have overlooked the strong performance of small-cap stocks.

The Russell 2000 index, which tracks the small-cap universe, is up 20% year to date, having outperformed the S&P 500 index, the Nasdaq Stock Market, the S&P 400 mid-cap index, and the Russell 1000 index. The outperformance extends over the past 12 months, as the Russell 2000 has returned 35%. The Nasdaq has returned 27%, while the S&P 500 is up 20% over that same stretch.

There are a few reasons for the small-cap surge, and a big one is a rotation out of overvalued large-caps. With large-cap valuations hovering at historically high levels, investors have sought out less expensive stocks.

Image source: Getty Images.

But it goes beyond that. As more and more AI infrastructure is being built, the AI supply chain expands to smaller suppliers and companies. Small-cap semiconductor stocks like Aehr Test Systems, MaxLinear, Navitas, and Wolfspeed have exploded with triple-digit returns in the first half of the year.

In addition, a robust mergers and acquisitions market typically has the effect of lifting all boats in the sector by generating more interest. Further, small-cap earnings have spiked. Wall Street analysts anticipate earnings of 38% to 48% for small caps in 2026, roughly twice the rate of the S&P 500.

Why a small-cap ETF is a good investment right now

This has been the best first half of the year for the Russell 2000 since 1991, when it rose about 26% through the first two quarters.

While the expected earnings growth is a great sign that this small-cap rally should continue, there are some concerns.

Specifically, small caps have benefited from declining rates over the past couple of years. However, the Federal Reserve has indicated that rising inflation could lead to a rate hike this year. That could slow some momentum, though it's unlikely to mark the start of a rate-hike cycle. Over the longer term, the Fed still expects rates to tick lower.

Additionally, small caps are inherently volatile. They are small, growing companies that often don't make a profit. Finding small caps with sustainable growth is not always easy. That's why the best option may be to invest in a small-cap ETF that tracks the Russell 2000 or some subset within it.

An ETF allows you to tap into the growth of the asset class while having a diversified mix of small caps.

An even better option, given the volatility of the Russell 2000 over the years, is to invest in an actively managed small-cap ETF like the Fidelity Enhanced Small-Cap Core ETF (NYSEMKT: FESM), which is up 26% year to date.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool recommends Wolfspeed. The Motley Fool has a disclosure policy.