Is it safe to invest in small-cap mutual funds?

In the past few years, investment in small-cap mutual funds has gained immense popularity amongst investors, especially the risk-takers. One of the prime reasons for this is the decent returns. In the last year, the category has on average delivered 120% returns. However, despite their high returns, small-cap mutual funds remain one of the most volatile equity funds categories.

Read below to know if it is safe to invest in small cap funds:

What are small-cap mutual funds?

Small-cap mutual funds invest majorly in companies with a market capitalization of less than Rs. 5,000 crores. If you invest in small cap funds, 65% of your portfolio will comprise small-cap stocks.

What aspects to consider when investing in small cap funds?

As specified, small cap funds can deliver high returns, but they are also highly volatile. Hence, when investing in this category of mutual funds, be wary of these factors:

  1. Your risk profile: Small-cap companies have short boom and bust cycles. This means that these mutual funds can perform exceptionally well in a bullish market cycle. However, they are also highly susceptible to losses during difficult market phases. Hence, these funds are ideally suitable for investors who have a high-risk appetite. If you are an aggressive investor and know when to enter and exit the market, you can consider investing in small cap funds to get the desired returns.
  2. Investment horizon: Smallcap funds are highly volatile. These funds can deliver significant returns in a short span but could also cause abrupt losses suddenly. Hence, invest in these funds if you understand the risks and have the patience to stay invested for a long period, like a minimum of seven years. Longer duration will help your portfolio absorb losses and balance them with the returns over the investment horizon. Your investment horizon also affects the taxation of your small cap funds. Short-term capital gains (investments up to one year) are taxed at 15%, and long-term capital gains (investment beyond one year) are taxed at 10% on the amount over one lakh.
  3. Investment returns: Small cap funds have the potential to offer more than 100% returns in a single day. However, they are also highly sensitive to the movement of the underlying benchmark. Hence, when investing in these mutual funds, aim to balance returns with risk. Assess the returns you want and calculate the risk you are willing to take for it.
  4. Investment cost: Small cap funds levy a fee to manage your funds. Even though SEBI (Securities Exchange Board of India) has limited the expense ratio of a mutual fund to 2.50%, it is still advisable to check the net return (after expenses) of the shortlisted short-cap mutual fund.

Conclusion

Small cap funds are best for aggressive and long-term investors, but they also offer optimal diversification for all types of investors. Hence, you can keep a limited portion of small cap funds in your portfolio to ensure you do not miss out on the high returns while limiting your risk exposure. It is always advised to conduct thorough research and plan before making your mutual fund investments. You can use any out of a wide range of verified investment apps to define your financial goals, find top-rated funds according to your risk appetite and invest in minutes. Tata Capital Moneyfy app have proven to be a preferred place for investors to start their mutual funds journey online. Pick the right one today to grow your wealth one investment at a time.


Natraj

Natraj Studied bachelor's degree in finance and business from Telangana University, Nizamabad. A Writer based In India, He has a degree in Charted Accounts and has very knowledgeable in credit repair and Banking Sectors. So, I decided to start a blog and share my knowledge to the visitors.

Leave a Reply

Your email address will not be published.