KNOWLEDGE CENTRE Mutual Funds Investment Guide / Should You Invest in Small-Cap Funds?
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Should You Invest in Small-Cap Funds?


Why is it important to have small cap funds in your portfolio

Mutual fund houses strive to maximize the wealth of an investor by investing in different securities. Based on the risk appetite of investors, they choose to invest in debt or equity funds.

Investing in equity securities basically means investing into stocks of different companies. As an investor, you need to keep in mind the risk-return balance with every investment you make. The fund managers invest in large-cap stocks, mid-cap stocks, and small-cap stocks.

What are the factors to consider before investing in small-cap funds?

With every investment, the profit and risk vary. Investing in small-cap funds is necessary for investors with long-term financial goals. Following are the factors to consider before investing in mutual funds:

  1. Returns of the fund
  2. Risk associated
  3. Growth potential of stocks
  4. Diversification benefits

Let us understand each of these in detail:

Return

Investors are always concerned about the performance of their portfolio. Every investor wants a higher return on their investment. Small caps funds may beat the performance of mid-cap and large-cap in the long run. It has been noted that after the large cap, it is the small-cap funds that perform tremendously well. They may give extraordinary returns when the market is bullish.

Risk

Investing in small-cap funds is risky since they are easily impacted by the volatility of the market. They carry a high risk-return tradeoff, which makes them ideal for investors with a high risk appetite. Investors should keep in mind that investment in small-cap securities is made for the long-term. Hence, any rise and fall in the prices due to the market movement will eventually wash out.

Growth

Small caps are the best choice when investors seek growth of their portfolio. The investment has the capacity to show tremendous growth and may reach higher when compared to large caps, which are already at the peak.

Diversification

The benefit of investing in mutual funds is the ability to diversify the portfolio. By investing in small cap, investors will be able to balance the risk-return tradeoff and diversify the entire portfolio so as to reduce their overall risk.

What are some of the strategies to invest in small cap?

In order to invest in small-cap funds, investors should follow the below-mentioned strategies.

Composition of the fund

There are a number of small-cap companies in the industry and an investor needs to gain detailed knowledge about them and their long-term returns before making an investment. The composition of the fund will bring a huge difference to the portfolio.

Investment objectives

Lay out your long-term financial plan before making an investment. Based on the same, choose to invest in small-cap equity funds to achieve long-term goals. For aggressive returns in the short term, this is not the right place to invest in.

Long-term investment

The trick to generating higher returns through equity is to remain invested for a long period of time. Investors need to keep in mind that it is not possible to maximize wealth overnight and they will have to remain invested into a small cap for a longer period of seven to ten years. This will ensure that the ups and downs of the market do not have an impact on the returns and the volatility is smoothened out.

Patience

With small-cap and mid-cap stocks, it is important to remain patient. The portfolio will not grow in a year and there is no point stressing over it. It will take a minimum period of three to four years for the fund to grow; hence being patient will help.

Quality matters

Investors should look for quality when choosing stocks to invest in. Many a time, investors try to make the most of the market cycle and invest in stocks that are valued at a lower price. But this could wipe out their entire investment. Choose quality stocks that have performed well in the past and have the potential to grow in future.

Risk appetite

Last but not the least, investors should evaluate their risk appetite before making an investment decision. Only those investors who may bear high risk should choose the fund. Remember, with higher returns come higher risk.

Investors should invest in small-cap equity funds after gaining detailed knowledge about the past performance of the fund and also the performance of the fund manager who handles small-cap securities.

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