Small-cap funds: Potential for high returns, but with higher risks

Small-cap mutual funds are those equity mutual funds whose investment portfolio consists of equities and equity-associated securities of companies ranked after 250 by market capitalization. Such funds provide high growth potential, usually over the long term. Their growth pace accelerates during favorable market conditions and is volatile during rough market scenarios. Read on to learn more about small-cap funds.

Small-cap funds

Why does small-cap mutual fund investment provide high growth prospects?

As small-cap mutual funds mostly put your investments in agile, promising, and high-growth generating smaller companies, the chances of yielding good returns are higher. Small-cap companies represent a rising economy. These companies could be startups with enticing market runs owing to their new service, technology, or idea. Additionally, small-cap companies provide considerable rewards with growth in the company’s share prices over the long term. This is because most small-cap organizations begin their journey in the stock market with a low cost, which makes them yield potential returns, and at times, the returns are often more than their counterparts, i.e., large caps and mid-caps.

Why do small-cap mutual funds have high risk?

Before you invest in a small-cap fund, ensure that the small-cap investments hold higher risk than the large-cap or mid-cap. This is because small-cap companies are new and inexperienced. As an outcome, smaller companies can be acquired easily by bigger ones even before they mature and head toward growth.

So, small-cap firms are risky as they are prone to market movements triggered by changes in economic upheavals and policies, both international and domestic. Thus, market vulnerabilities tend to put small-cap funds at a higher risk.

Who can invest in small-cap funds?

Those who could weather or bear potential losses due to their high-risk appetite can consider investing in small-cap mutual funds. Also, as smaller companies usually take time to mature and grow, those who can remain invested for long-term periods for higher growth can consider investing in small-cap funds.

Many enterprises that began young have turned into big organizations. So, investing in a small-cap mutual fund can be highly rewarding for i.e. long-term and short-term retail investors. While fund managers factor in the risk parameters involved in small-cap firms, there are a few things that you, as an investor, must consider when selecting the funds.

For example, the company must have the sound financial strength to sustain itself in the market. Besides this, you must also consider looking at the small-cap company’s operating margin, sales, quality management, and profits to make an informed decision. Study the fund’s risk appetite level, past track record, expense ratio, and potential to yield returns. If you are new to mutual funds, consider the SIP (Systematic Investment Plan) mode to begin with your market investment. Here, instead of making lumpsum investments, you systematically put a small amount of contribution on periodic intervals across all market cycles to benefit from the rupee cost averaging and compounding effect. Doing so allows you to reap the highest benefits and safeguard your investments against volatility.


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