Mutual fund schemes can be divided into several types based on the criterion of their categorisation. When investors categorise them based on the companies they invest in, they are often divided into three types – small-cap funds, mid-cap funds, and large-cap funds. Large-cap funds and mid-cap funds invest in companies that have a “large” (₹ 20,000 crore or more) and a “medium” (between ₹ 5000 crore and ₹ 20,000 crore) market capitalisation. Small-cap funds, on the other hand, have a “small” market cap. This article helps investors invest wisely in small-cap mutual funds.
What are small-cap mutual funds, and how to they work?
Small-cap mutual funds invest around 65% of their investment capital in small-cap stocks. These are the stocks of companies that have a market capitalisation less than ₹ 5,000 crores. These companies are smaller in size and have a promising growth potential. Individuals invest in these funds since they offer the potential for higher returns; however, they also pose a high-level risk to the investor.
Tips to invest wisely in a small cap fund:
Small-cap mutual funds come under the “high risk, high returns” category of mutual fund investments. Investors must, therefore, consider a few points before investing their capital in a small-cap fund. Here are five tips that you can follow while investing in these funds:
- Consider the potential returns and the investment horizon: It is no secret that small-cap mutual funds offer high returns. However, you must shortlist a few small-cap funds and analyse their returns by using an SIP calculator to select the fund that benefits you the most.
- Analyse your risk-taking capacity: Small-cap funds also pose a very high risk to the investor; and are highly susceptible to market volatility. It is, therefore, prudent for the investor to undertake a detailed risk assessment of their investment portfolio before making a small-cap investment.
- Know about the liquidity offered by small cap funds: Since companies with a small market capitalisation have lower trading volumes, it is difficult for small-cap fund investors to buy or sell shares quickly. Investors must know about the lower liquidity offered by small-cap funds before investing their capital in them.
- Read about the fund’s management before investing: Small-cap companies may have lesser-experienced asset management teams, which can lead to a greater risk of fund mismanagement. You must, therefore, read about a small-cap fund’s management before investing in the fund.
- Diversify your investments to manage risk: Investors must also be sure to diversify their small-cap investments to reduce their portfolio’s overall risk. Investors must consider diversifying their capital across multiple small-cap mutual funds to manage the high risk posed by these funds.
Before making any mutual fund investment, it is prudent for the investor to use a mutual fund SIP calculator. Doing so can help the investor know the exact value of their mutual fund investment before investing. Small-cap fund investors must do the same to decide on the ideal investment amount and investment tenure for their small-cap investments.
