- The Russell 2000 is a stock market index made up of 2,000 small-cap US companies.
- It is a widely used performance benchmark for funds that invest in small-cap equities.
- The broad cross section of US-focused companies in the Russell 2000 also makes it a barometer for the economy.
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The Russell 2000 is a stock index that tracks the performance of 2,000 small-capitalization companies and often serves as a measure of the underlying health of the US economy. It comprises the smallest companies included in the broader Russell 3000 Index, and is one of the most widely used benchmarks for funds that invest in small-cap stocks.
The Russell 2000 accounts for 10% of the market capitalization of the Russell 3000, which represents around 97% of the investable US equity market. Both are operated by FTSE Russell.
How does the Russell 2000 Index work?
As with the Russell 3000 and many other equity indexes, the Russell 2000 is weighted by market-capitalization. This means that stocks with greater market value have a proportionally larger impact on the index’s overall level.
To be included in the index, companies must first be part of the Russell 3000, which comprises the 3,000 largest US-traded equities. FTSE Russell then picks the 2,000 smallest stocks from this index, removing such multibillion-dollar corporations as Microsoft, Apple, and Alphabet, leaving the companies that make up what could be considered the ‘core’ of the US economy.
“The Russell US indexes were created over 40 years ago and have been a key barometer of the US economy,” says Edward Moya, a senior market analyst at New York-based foreign-exchange broker OANDA. “Depending on which stage an economy is in, its expansion cycle might determine whether an investor wants to buy large-cap or small cap-stocks.
Some of the largest firms in the index include AMC, Asana, Crocs, and Macys, with market values in the $10 billion-$20 billion range as of November 2021. Conversely, some of the smallest members include biotechnology pharmaceutical companies such as Forte Biosciences and Hookipa Pharma, which had market values of less than $1 billion.
Russell 2000 members ranked by market value (November 2021)
How is the Russell 2000 different from other major indexes?
Given that it covers a larger number and broader range of companies than the Dow Jones Industrial Average or the S&P 500, the Russell 2000 exhibits slightly different behavior from these and other major market gauges.
“Small-capitalization stocks tend to be more economically-sensitive and cyclical than large-capitalization stocks,” says Ari Wald, a technical analyst at Oppenheimer. “That is, they both rise and fall by a greater magnitude through the ups-and-downs of an economic cycle.”
Another thing to keep in mind is that the Russell 2000 is composed according to different rules than other indexes, including some such as the S&P 600 that track small-cap stocks as well.
“The S&P 600 has a financial viability requirement for companies, whereas the Russell 2000 does not,” says Ross Mayfield, an investment strategy analyst at Baird Wealth. “This can result in a higher percentage of unprofitable companies being included.”
On the flipside, there can be a greater potential for growth, given the smaller size of the average Russell 2000 company. It also tends to be more diverse and broader than other popular small-cap indexes, something that arguably makes it more representative of the ‘real’ economy.
How to invest in the Russell 2000 Index
For investors, the Russell 2000 has a number of interrelated uses.
“Individual investors can gain exposure to the Russell 2000 by mutual funds and exchange-traded funds (ETFs) that attempt to replicate the performance of the index, though it is not possible to invest directly in an index,” says Wald.
While mutual funds tracking the Russell 2000 are available, ETFs are more common. These are some of the largest:
- BlackRock iShares Russell 2000 ETF (IWM)
- Vanguard Russell 2000 ETF (VTWO)
- ProShares UltraPro Russell2000 (URTY)
Wald also highlights the benefit of using the Russell 2000 as part of a balanced asset allocation process, since owning both small- and large-capitalization stocks can help diversify a portfolio. This especially comes into play at different stages of the economic cycle, with small-cap companies often promising better-than-average returns during upswings, largely because their revenues are concentrated domestically.
“If the US economic outlook is strong, historically the Russell 2000 Index should perform nicely,” Moya says.
Mayfield points out that the Russell 2000 can be used simply as a benchmark or frame of reference for investors looking to narrow their focus onto more specific areas.
“It can be used to benchmark performance for active managers, as the underlying index for a passive investment (e.g. exchange-traded fund), or simply as a reference point for an investor who wants a broad gauge of how small cap stocks are doing,” he says “Both institutional and retail investors can use the index. Since it is one of the most commonly referenced in the world, nearly everyone who invests in the small cap space might use it or come across it.”
The financial takeaway
The Russell 2000 serves as a benchmark for small-cap funds and a barometer for the overall health of the US economy. Investors, mostly through exchange-traded funds, can use it to gain exposure to the cyclical swings of the US economy, although this carries risks during downturns and recessions.
As such, investing in the Russell 2000 through an ETF requires a researched understanding of the state of the US economy, and it works well as part of a diversified approach that sees small-cap stocks or funds being balanced out with investment in large-cap alternatives.