Are you thinking about investing in equity mutual funds? One of the first steps is to choose the right category – large-cap, mid-cap, small-cap, multi-cap, or sectoral funds. Each has its pros and cons.
What Are Small-Cap Funds?
Small-cap funds invest mostly in companies that are smaller in size or have a lower market capitalization. These funds typically allocate 60-90% of their portfolio to small-cap stocks, with the rest in mid-caps and large-caps to balance the risk.
Mutual fund houses that offer small-cap funds have teams of professionals who select the right mix of stocks. The success of these funds depends on how much effort the fund managers put into researching and finding promising small-cap companies.
Why Small-Cap Funds Aren’t for Everyone
While small-cap funds can give high returns, they come with their share of risks. Here are three reasons why you might want to avoid small-cap funds:
1. High Risk
Small-cap funds are quite risky. In the short term, they can lead to losses. If you’re someone who can’t handle seeing your investment value drop during certain periods, then small-cap funds may not be for you. These funds tend to have sharp ups and downs, so if volatility worries you, it’s better to look at more stable options.
2. Not Ideal for New Investors
Are you new to investing? It’s easy to be attracted by the high returns of small-cap funds, but for beginners, it’s better to start with other types of mutual funds. Once you’re more familiar with how mutual funds work and understand their risks, you can consider small-cap funds.
These funds are best suited for investors who have a good understanding of the market and mutual funds.
3. Unsuitable for Short-Term Investors
If your investment horizon is short, you should avoid small-cap mutual funds. These funds tend to perform well over longer periods but are highly volatile in the short term. Although gains are possible, the risk is higher.
For short-term investors, safer options like low-risk debt mutual funds are a better choice. When it comes to small-cap funds, you need to stay invested for at least 5-6 years to see significant returns.
How to Invest in Small-Cap Funds
1. SIP/STP
One smart way to invest in small-cap funds is through a Systematic Investment Plan (SIP), where you invest a fixed amount every month. This spreads out your risk over time. If you have a large sum to invest, consider using a Systematic Transfer Plan (STP) instead. With STP, you invest your lump sum in a debt mutual fund and gradually transfer that money into an equity mutual fund. This approach allows you to earn a better return compared to keeping your money in a savings account. Read more here Understanding the Differences: Large Cap, Mid Cap, and Small Cap Funds.
2. Think Long Term
Always consider small-cap funds as a long-term investment. These funds can be very volatile in the short term, but over time, they tend to deliver good returns.
Conclusion
Choosing the right mutual fund depends on your investment objectives. Most investors agree that investing for the long term is the best way to maximize gains and reduce risk.
FAQ
Quick, blog-friendly answers to common questions.
A Systematic Investment Plan (SIP) is a way of investing a fixed amount in a mutual fund at regular intervals, usually monthly. In real market conditions, SIPs spread your investments across different market levels. When markets are higher, the same amount buys fewer units. When markets are lower, it buys more units. Over time, this can help average the purchase cost.
SIPs can be useful during volatile phases because they reduce the pressure to time the market. You keep investing through ups, downs, and sideways phases with the same routine. Instead of reacting to daily market movement, SIPs help maintain consistency and stay aligned with your objective.
Compounding is when your returns start generating returns of their own. In the early years, growth looks slow because the base is small. Over time, as the base grows, even the same rate of return can create larger gains—this is the “snowball” effect.
The key drivers are time, consistency, and patience. Start early, invest regularly, and avoid interrupting the process. Compounding feels quiet at the start and becomes meaningful when it gets time to work.
Mutual fund investments are subject to market risks. Read all scheme related documents carefully.
