Is It Good To Invest In Small Cap Funds: When the investing community was slowly paying attention to the mutual fund idea, one type of fund, in particular, stood out – Small Cap Funds?

They invest in smaller, high-potential companies that have the scope of growing rapidly. While Large Cap and Mid Cap funds are safer and more consistent, small-cap funds have been known to be volatile and rapidly growing.

Do you also have this question in your mind – Is It Good To Invest In Small Cap Funds? Let’s take a brief look at the types of mutual funds and why they are differentiated.

Types Of Mutual Funds 

Based on the size of the companies, there are mainly 3 types of mutual funds – Large Cap, Mid Cap, and Small Cap Funds.

1. Large Cap Funds

A large-cap fund is an equity fund that invests a major proportion of its assets in large companies. By large companies, we mean gigantic organizations such as the Tata group, Reliance, HDFC, etc.

These are companies that have an established record, positive public reputations, and consistent growth and performance. 

2. Mid-Cap Funds

A mid-cap fund, as the name suggests is an equity fund that invests in companies that are in the middle range on the stock exchange. 

These funds offer higher growth than large-cap funds and lower risk than small-cap funds, bringing the best of both funds into one. 

3. Small Cap Funds

A small-cap fund invests a majority of its funds into companies that are upcoming and fairly young. A small-cap company is a listed entity with a market capitalization of less than or equal to ₹5,000 crores.

Small-cap companies are new, with little to no track record, and have a volatile performance history. Now that you know the 3 basic types of mutual funds, let’s take a look at the reasons why you should and should not invest in a small-cap fund.

Why You Should Invest In A Small-Cap Fund 

1. High Growth Potential

Imagine investing in Titan before it became the Titan of jewellery and watches. In hindsight, investors always look back at such opportunities with regret.

Small-cap funds allow you to invest in such companies that have not yet peaked at their growth potential. They are still growing and have the potential to become the next big conglomerate. 

2. Good For Diversification

For established investors who already have stakes in different large-cap and mid-cap funds, small-cap funds offer an opportunity to diversify their portfolio. In off seasons when large-cap companies do not perform, small-cap funds can be an alternative.

3. Overlooked And Hidden Gems In The Stock Market

Small-cap companies are overlooked by large investors such as FIIs and DIIs, which gives ample opportunity to investors to multiply their investments.

4. Focus Oriented 

Larger companies are diversified in terms of their business operations. Almost all companies start off with one product/service and then transition to other industries.

Small-cap companies are more focused on their present business lines, which gives them the edge of rapid growth.

Why You Should NOT Invest In A Small Cap Fund

Now that we’ve taken a look at the advantages of investing in small-cap funds, let’s take a look at its downsides. 

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1. Higher Risk

While small-cap funds give great growth potential, they also carry immense risk. These smaller companies are highly susceptible to competition, economic reforms, and smaller presence.

This makes the fund itself highly volatile and risky to investors. Furthermore, small-cap companies have higher volatility in the market, with higher-than-usual price movements. This makes small-cap funds suitable for investors with a higher risk tolerance than most. 

2. New Investors

If you’re a new investor who has just entered the market, small-cap funds might not be the best place to begin. This is especially true if have not personally experienced market movement with your own holdings.

New investors tend to be lured into small-cap funds due to high returns. But they tend to overlook that with the high reward also comes high risk.

3. Lower Dividends

As small-cap companies need capital to grow, they tend to reinvest most of their profits. This makes the likelihood of receiving dividends on small-cap stocks quite unlikely, compared to large-cap and mid-cap funds. 

4. Not Recommended For Short-Term Investors

Remember that small-cap companies are still growing and they are in the initial stages of business. If your investment has to grow to a significant amount by solely investing in a small-cap fund, then the companies within the fund also have to grow consistently.

This takes longer than mid-cap and large-cap companies as they have a smaller market share, need revenue to grow, and face short-span volatility. 

So small-cap funds are not recommended for short-term investors who may redeem their investment prematurely.

Is it Better To Invest in Small-Cap or Large-Cap?

Small-cap funds carry a high risk-high reward factor. While this is good for investors with a bigger risk appetite, it can also cause losses as well. Large-cap funds, on the other hand, are for stable and consistent growth. They grow slower but are steady and relatively low-risk.

Also Read: Which Is The Best Investment Plan In India For Middle Class?

In Closing

Small-cap funds have their advantages and disadvantages, just like mid-cap and large-cap funds. There is no straightforward answer of yes or no to the question – Is It Good To Invest In Small Cap Funds?

It truly depends on you, the investor, and your risk tolerance. Those with higher tolerance might prefer it, whereas conservative investors would choose a secure fund.

Whatever your preference may be, it is always best to arm yourself with the best investment – Knowledge. Check out the courses on FinGrad, which is a better return than any other investment right now. Happy Investing!

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