Are Small-Cap funds good investments?

Introduction

Equity mutual funds are fast becoming a popular option among investors who want to grow their wealth. While most people tend to stick to large-cap mutual funds because of its reputation, there has been a sudden spike in interest in small-cap funds.

Small-cap funds are mutual funds that invest at least 65% of its money in small-cap companies—that is, companies that rank below the top 250 companies in terms of market capitalisation. In comparison to large cap and mid cap companies, these companies have lower revenues or are in nascent stages of growth. However, since these firms are small in size, the right small-cap companies also have the potential to grow fast.

Why invest in small-cap mutual funds?

When you invest in small-cap funds, you invest in the best small-cap companies with growth potential. Small-cap companies tend to do well during a bull market, and often, these outperform mid-cap and large-cap companies.

However, be mindful of the volatility in small-cap company prices. The share prices of small-cap companies fluctuate wildly. That’s because these are not yet financially stable and are still finding their footing. During a bear market, the stock prices of these companies can fall sharply.

Despite the volatility and downside risk, small-cap companies can perform well in the long run. The best small-cap mutual funds hunt for small-cap companies that show promise. These companies are most likely to expand and provide superior returns to investors.

If you have a high risk appetite and want to generate a handsome corpus, in the long run, you could consider investing in the top small-cap mutual funds. Steer clear of small-cap mutual funds if your investment horizon is not at least for seven to ten years. This timeline provides an opportunity for market volatility to stabilise and give you the expected returns.

Should you invest in small-cap mutual funds?

The answer to this rests primarily on your risk appetite. As outlined earlier, even the best small-cap funds are subject to volatility. Small-cap funds can throw you off if you believe that you cannot keep your cool with market fluctuations.

On the other hand, if you can stomach market volatility, you could consider investing in small-cap mutual funds for its superior return potential. Stay invested in these equity mutual funds for the long term so that you can reap substantial benefits.

Another aspect to consider is the amount of exposure you have to small-cap mutual funds in your overall portfolio. Since these are high-risk investments, experts suggest that out of your overall investment portfolio you should invest in small-cap funds to a certain extent only. This will ensure that you have a well-balanced portfolio that can absorb losses if a portion of your investment does not meet your expectations.

Conclusion

Small-cap funds can make suitable investments for individuals with a high-risk appetite who are willing to stay invested in the long run. However, it would help if you were careful about how much of your total portfolio you allocate towards small-cap funds. Monitor your investments regularly and do your research to invest only in the best small-cap funds.

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