Is Now the Time to Move Away From the "Magnificent Seven" and Into Small-Cap Stocks?

The "Magnificent Seven" stocks are the leading tech giants in the world, whose valuations eclipse more than $1 trillion in market cap today. Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla are household names that have generated mammoth returns over the past decade. Meta Platforms is technically the worst of the bunch, with a 10-year return of around 540%, which is still far better than the S&P 500's gains of roughly 265% over that time frame.

However, the past 12 months have been a very different story with the S&P 500 outperforming all but two of the Magnificent Seven stocks (Alphabet and Nvidia being the exceptions). Investors have been growing concerned about rising valuations in the market of late, and a pullback from these tech giants could be proof of that apprehension.

Is investing in the Magnificent Seven stocks still a good idea, or could this be the year to focus on small-cap stocks instead?

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The big advantage of going with the Magnificent Seven

The Magnificent Seven are all strong businesses that generate excellent financial results. Their high valuations can make them vulnerable to corrections, but the businesses themselves are going nowhere. They can and will adapt to changing market conditions. They have the financial strength to pivot quickly, unlike small-cap stocks.

It's also easy to hold a position in all the stocks without buying them individually. This is where the Roundhill Magnificent Seven ETF (NYSEMKT: MAGS) comes into play. It invests in the Magnificent Seven, and its expense ratio of 0.29% isn't terribly high. In the past 12 months, the fund has risen by around 15%.

With small-cap stocks, you'd be taking on much more risk in exchange for the hope that they soar in value. They often need cash infusions, which is why they can do well in a low-interest-rate environment. But with potentially few rate cuts this year, 2026 may not be the ideal time to be holding these types of stocks. That's why going with the Roundhill Magnificent Seven ETF can still be an attractive option right now. However, that doesn't mean going with small-cap stocks is a bad move.

The smarter way to invest in small-cap stocks

Picking individual small-cap stocks can be risky, but with an ETF such as the iShares Russell 2000 ETF (NYSEMKT: IWM), the fund's diversification can drastically reduce your overall risk. It has close to 2,000 stocks in its portfolio, and even the largest holding accounts for barely 1% of the fund's total weight.

Even if some of the fund's stocks struggle, the lack of significant exposure to any individual holding may still leave investors fairly safe overall. The fund's expense ratio is also more modest at 0.19%, compared to the Roundhill fund, despite offering significantly more diversification. In the past 12 months, the ETF has risen by 17%.

By investing in the iShares fund, you can get the best of both worlds: reduced risk and the opportunity to benefit from the growth in emerging small-cap stocks. In 2022, when the S&P 500 crashed by 19%, the iShares Russell 2000 ETF incurred a slightly worse decline of 22%. However, every single Magnificent Seven stock did worse; Apple's 27% decline that year made it the best performer of the group.

Going with the iShares Russell 2000 ETF can, ironically, be the safer move in the long run, which is why it's the ETF I'd go with this year. The heightened valuations in the Magnificent Seven could make the Roundhill fund much more vulnerable to a steep sell-off.

David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.