3 Reasons Why You Should Not Invest in Small-Cap Funds

10 August 2022
4 min read

Thinking of investing in an equity mutual fund?

Well, we know it is crucial to decide the most appropriate category – i.e. large cap, mid cap, small cap, multi-cap or sectoral. Each category has its own advantages and disadvantages.

What Exactly is a Small-Cap Fund?

In small cap funds, a large portion of the investment is done in companies that are small in size or have a small capitalization.

Most small-cap funds invest around 60-90% in small caps and the rest in mid-caps and large caps to provide some stability to the investment.

Mutual fund houses offering small-cap funds have professional fund management teams with the requisite expertise in selecting the right amount of equity in each portfolio.

The success of these funds depends on the amount of time invested by fund houses in researching and finding the right dark horse stocks in the small-cap segment.

Over the last month, small-cap funds are down by 8%. But do not forget that in 2017, they were up by 55%.

Not only that, in terms of 10-year returns, small caps are definitely the best-performing funds.

Why Are Small-Cap Funds Not For All Kinds of Investors?

Small-cap mutual funds have given stellar returns. But have you ever wondered, ‘what are the disadvantages of small-cap funds?’.

Here are 3 reasons why you should stay away from small-cap funds. But wait, if these 3 points are not a problem, you should definitely invest in small-cap funds.

1. Risk

Small-cap mutual funds are very risky. This means that in the short term, investing in them could lead to short-term losses.

If you cannot tolerate seeing negative returns on your investments at specific periods, you should stay away from small-cap funds.

If you cannot see such sharp ups and downs, it is better to stay away from small-cap funds. Explore investing in Large Cap Funds instead.

2. New Investor

Are you a new investor?

Don’t simply get swayed by the higher returns.

In fact, for new investors, it would be best to start investing in other category mutual funds. Once you know the performance of mutual funds, you can explore small-cap funds.

These funds are best suited for investors with a very good idea about mutual funds and their risks.

3. Short-Term Investor

If you are investing in mutual funds for a short duration, stay away from small-cap mutual funds.

Small-cap mutual funds perform well over a long period of time. However, over a short period of time, they tend to be very volatile.

So if you plan on withdrawing/redeeming your money from the mutual fund early, you could suffer losses. Sure, you could also make gains, but there is always the risk.

Hence, if you are a short-term investor, stick with low-risk debt mutual funds.

As for small-cap mutual funds, you should remain invested for at least 5-6 years.

How to Invest in Small Cap Funds

1. SIP/STP

Investing in small-cap funds via SIP (Systematic Investment Plan) is a good idea.

SIP refers to investing a fixed amount in a mutual fund every month. What SIP does is it spreads your risk over a considerable period of time.

If you have a large sum of money you want to invest, SIP is not the best option to go with. Instead, explore the STP (Systematic Transfer Plan).

In STP, you invest your money in a debt mutual fund. And then, you gradually transfer that money to an equity mutual fund of your choice.

It is like starting a SIP but instead of paying from your bank account, you are paying from a debt fund.

This allows you to earn a higher rate of return as debt funds give higher returns when compared to savings bank accounts.

2. Long Term

With small-cap mutual funds, always opt to invest for the long Term. Therefore, the minimum period for which you should be investing in small-cap mutual funds is 5-6 years.

As mentioned earlier, small-cap mutual funds tend to be very volatile. For example, they may go up and down in the short Term.

Over a long period of time, they tend to give good returns.

Conclusion

There are a lot of factors you should take into consideration before selecting a mutual fund scheme that matches your investment goals.

Mutual fund investors in India may disagree on strategies and fund choices. But one of the few things that most would agree on is that investing for the long-term is an ideal method to maximize potential gains and reduce risk.

Investing in mutual funds online is very simple and paperless. Log in to your Groww account, choose a fund, and invest using net banking – exactly like you would when shopping online.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww. 

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
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