Mutual funds are a popular investment vehicle that can help you save money and generate substantial returns over time. They come in various forms, catering to different market capitalizations and risk profiles. If you’re new to the world of mutual funds, you may encounter terms like Large-cap funds, Mid-cap funds, and Small-cap funds. Understanding these concepts is essential for making informed investment decisions.
What is Market Capitalisation?
Market capitalisation, often referred to as ‘market cap,’ is the total market value of a company’s outstanding shares. It is a critical indicator of a company’s size and overall market presence. Market cap is calculated by multiplying the current share price by the total number of outstanding shares. This metric helps categorize companies into different segments, which are generally classified as large-cap, mid-cap, and small-cap based on their market value. Read here to know about the Terms Associated with Mutual Funds That You Need to Know.
These categories are crucial as they guide investors in choosing the right mutual funds based on their risk tolerance and investment objectives.
Large-cap Companies
The top 100 companies by market capitalization are termed as large-cap companies. Mutual funds that invest primarily in these large-cap companies are known as ‘Large-cap funds’. These companies, often referred to as ‘blue-chip stocks’, have a robust market presence. They are generally well-established, with a long track record of stability and profitability. Read our blog How to Effectively Evaluate Mutual Fund Performance to know more about Mutual Fund Performance.
Investing in large-cap funds is typically considered less risky compared to mid-cap or small-cap funds, as these companies are usually industry leaders with consistent performance and high liquidity. Their stocks are less volatile, making large-cap funds an attractive option for conservative investors seeking steady returns over the long term.
Mid-cap Companies
Mid-cap companies are those that rank between 101st and 250th in terms of market capitalization. Mutual funds that invest in these companies are called ‘Mid-cap funds’. Mid-cap companies are often in the growth phase, with significant potential for expansion and profitability, but they also carry a higher risk than large-cap companies.
Mid-cap funds are suitable for investors who are willing to take on a bit more risk in exchange for the possibility of higher returns. These companies might not have the same level of market dominance as large-cap companies, but they often show promising growth prospects. However, the higher risk associated with mid-cap funds comes from the fact that these companies may face more significant challenges in terms of market competition and economic downturns.
Small-cap Companies
Small-cap companies are those ranked 251st and beyond in terms of market capitalization. Mutual funds that invest in small-cap companies are known as ‘Small-cap funds’. 3 Important Factors to Consider Before Investing in Small-Cap Funds. These companies are typically younger, less established, and may not have a long track record. Start-ups and companies in the early stages of development often fall into this category.
Small-cap funds are generally considered high-risk investments, but they also offer the potential for high rewards. Investors in small-cap funds can expect more significant price fluctuations and higher volatility, as these companies are more susceptible to market changes and economic challenges. However, for aggressive investors with a high-risk tolerance, small-cap funds can be an attractive option, especially if they are looking for opportunities to invest in companies with high growth potential.
Comparing Large-cap, Mid-cap, and Small-cap Funds
Risk Profile
• Large-cap funds: Offer a lower risk profile due to the stability and established nature of the companies they invest in. These funds are suitable for risk-averse investors who prioritize capital preservation.
• Mid-cap funds: Present a moderate risk profile, with more potential for growth than large-cap funds but also greater risk. They are ideal for investors who are comfortable with some level of risk and are looking for growth opportunities.
• Small-cap funds: Carry the highest risk due to the volatile nature of small-cap companies. These funds are best suited for aggressive investors who are willing to endure significant price fluctuations in exchange for the possibility of substantial returns.
Liquidity and Volatility
• Large-cap funds: Generally, less volatile and offer high liquidity, making them a safer choice during market downturns. Their stocks are widely traded, ensuring ease of buying and selling.
• Mid-cap funds: Exhibit moderate volatility and liquidity. While not as stable as large-cap funds, mid-cap funds can still provide a balance between risk and return.
• Small-cap funds: Highly volatile with lower liquidity. The stocks of small-cap companies may not be as readily traded, making them more susceptible to sharp price movements and more challenging to liquidate.
Returns
• Large-cap funds: Provide steady and consistent returns, with less fluctuation compared to mid-cap and small-cap funds.
• Mid-cap funds: Offer higher returns compared to large-cap funds. These funds are suitable for investors seeking a higher return with moderate risk.
• Small-cap funds: Despite their high risk, small-cap funds can offer substantial returns. They are ideal for investors looking for high growth opportunities.
Who Should Invest?
• Large-cap funds: Suitable for conservative investors who prioritise stability and are looking for long-term returns. Large-cap funds are suitable for those who prefer a less aggressive investment approach. read our blog to know more about Multi-Cap Funds vs. Flexi-Cap Funds – What’s the Difference?.
• Mid-cap funds: Suitable for investors with a moderate risk tolerance who are willing to invest for the long term. These funds can provide a good balance between risk and return, making them an attractive option for growth-oriented investors.
• Small-cap funds: Suitable for aggressive investors with a high-risk tolerance and a shorter investment horizon. These funds require careful research and monitoring, as the companies they invest in are more susceptible to market volatility.
Growth Potential
• Large-cap funds: These companies have a solid reputation and are likely to generate stable returns, making them a safe bet for long-term investors.
• Mid-cap funds: Offer moderate growth potential, with a higher risk-reward ratio compared to large-cap funds.
• Small-cap funds: Considered to have the highest growth potential among the three, but also come with the highest level of risk.
Key Takeaways
1. Large-cap funds offer lower risk and stable returns, making them suitable for conservative investors.
2. Mid-cap funds strike a balance between risk and return, ideal for investors with moderate risk tolerance.
3. Small-cap funds provide the potential for high returns but come with significant risk, suited for aggressive investors.
4. Understanding your risk tolerance and investment objectives is crucial in selecting the right mutual fund.
