Category : New to Investing January 23, 20265 minutes read
Small cap mutual funds invest in equities of smaller companies that are ranked below the top companies by market capitalisation. These companies are often in their early growth stages and may offer significant expansion potential, but they also come with higher levels of risk and volatility. As a result, small cap mutual funds are generally considered high-risk, high-reward investment options.
Due to their exposure to market fluctuations, economic cycles, and company-specific risks, small cap funds are not suitable for every investor. Their performance can vary widely in the short term, and periods of underperformance are common. Therefore, it is important for investors to carefully evaluate their risk appetite, investment horizon, and financial goals before investing.
Small cap mutual funds may be more suitable for investors who are willing to stay invested for the long term, can tolerate short-term volatility, and are seeking higher growth potential. Understanding who should invest in small cap funds can help investors make informed decisions and align these investments with their overall portfolio strategy.
Small cap mutual funds invest in small cap stocks. By nature, small cap mutual funds and small cap stocks may be suitable for similar types of investors. As a high-risk investment option, it is vital for investors to consider the advantages and disadvantages of small cap mutual funds before investing.
The following types of investors may potentially benefit from an investment in a small cap fund.
High-Risk Investors
Small cap funds invest in small cap stocks, which are inherently risky. Small cap stocks are stocks of companies listed below the top 250 companies on the stock exchange. Consequently, they may be volatile and risky. These stocks may be more severely impacted by market fluctuations, policy changes, and other macroeconomic factors. As a result, the performance of a small cap fund may be volatile. As a result, investors who have a high-risk tolerance and can withstand such fluctuations are generally considered suitable for small cap funds.
Long Term Investors
We understand that small cap mutual funds and stocks are vulnerable to market fluctuations, and their performance can be severely impacted by external factors. For investors to be able to withstand this volatility, they must remain invested for a longer period of time. Generally, over the course of five to ten years, investors are able to ride out the volatility and potentially generate returns. Moreover, smaller companies take time to grow, expand operations and improve profitability.
By staying invested for a longer period, investors can also potentially benefit from the power of compounding. This means that potential returns from the small cap fund get reinvested, and investors have the potential to earn returns on the returns as well as the original amount.
Investors Seeking High Growth
While small cap mutual funds are a high-risk investment option, they are also a potentially high-growth investment option. Although the returns from a small cap fund are never guaranteed and subject to market conditions, analysis of small cap funds generally shows that they are a high-risk-return scheme. Investors who are looking for a source of regular income or a place to store their excess funds and create an emergency fund may not prefer small cap mutual funds.
Invest in Bandhan Small Cap Fund today!
Can Handle Short-Term Underperformance
Since small cap mutual funds invest in small cap stocks they are subject to market fluctuations and volatility. During market downturns, small cap mutual funds may underperform. Generally, over the long-term and through market cycles, the potential returns adjust; however, certain periods may experience underperformance. Investors who are able to handle such short-term fluctuations and underperformance may be suitable for small cap mutual funds.
Investors Who Have a Diversified Portfolio
Small cap mutual funds are generally considered a suitable addition to an already diversified portfolio. These schemes invest in only one market cap, i.e., small cap, increasing their risk level. During market downturns, all small cap stocks may perform poorly. Investors who have a diversified investment portfolio may be able to withstand this, whereas a lack of diversification may lead to losses. Nevertheless, small cap funds are diversified across sectors such as technology, IT, pharmaceuticals, agriculture, consumer goods and services, etc. The diversification across sectors may help offset some risk.
Read more about the benefits of portfolio diversification.
Investors Comfortable with Low Liquidity
Small cap stocks generally have lower liquidity, as they have lower trading volumes. Lower liquidity means buying and selling stocks at a fair price can be difficult. Thus, investors who are comfortable with lower liquidity may prefer small cap investments. Nevertheless, within a mutual fund framework, investors are free to redeem their investment at any time and are not bound by a lock-in period.
Young Investors
Small cap mutual funds are generally recommended for younger investors as they can remain invested for a longer time frame, and they may have the ability to withstand more risk. Moreover, the longer investors stay invested, the greater the benefits of compounding. Comparatively, older investors may require stable and regular savings and income. Short-term fluctuations and volatility in small cap funds are less concerning when there is ample time for recovery and growth.
Investors Seeking SIP
Although investors can invest in small cap funds through lumpsum or Systematic Investment Plans (SIPs), generally due to the high-risk associated, SIPs may be considered. This allows investors to put in a small amount of money on a regular basis and gain the potential benefit of Rupee Cost Averaging (RCA) and benefit from compounding. Regular, small investments can help average out the risk and potentially create significant returns from small cap funds.
Investors who wish to follow a passive investment strategy may choose to invest in small cap index funds. These funds track a small cap index, such as the Nifty 250 index, which tracks small-cap funds across various sectors. A passive investment means investors are subject to a lower expense ratio, and the scheme replicates the index performance. Although it does not aim to outperform the index, there is a lesser risk related to the investment strategy and any potential bias.
Adopt a passive investment strategy and invest in Bandhan Index Funds today!
Small cap funds are a type of investment scheme that invests in small cap equities. Due to their investment portfolio, they are generally suitable for investors with a high-risk and long-term investment horizon, as they can withstand volatility. Due to their high-risk portfolio, they are suitable for investors with an already diversified portfolio and may be a better fit for younger investors looking to start an SIP.
