Factors to consider before investing in small-cap funds

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June 25, 2021 4:08 PM

Some of the advantages of investing in small-cap funds include exponential growth potential, availability at a lower price, among others.

small cap funds, mutual fund, small-cap equity mutual funds, mutul fund investment, MF, stock market, maximise investment benefits, high returns, the BSE Small Cap Index, large caps, maximise your wealthWithout the proper knowledge, one could end up losing all their money while speculating and time timing the market.

Small-cap stocks are the stocks of publicly traded companies that have a market capitalisation of less than Rs 5,000 crore. Experts say these underlying companies are more volatile and vulnerable to losses during downtime in the market, as they are young and seek to expand aggressively. In a small-cap fund, the fund manager invests a minimum of 65 per cent of the portfolio in small-cap stocks.

Having said so, small-cap funds are suitable for those who are willing to take high risks and also know when to exit the market. Experts say, the decision to invest in small-caps at this stage should not be based on playing momentum or by the fear of missing out.

Harshad Chetanwala, Co-founder MyWeathGrowth says, “With Small-cap funds, the ideal way to look at it is even if the cycle turns, which small-cap stock you will be comfortable holding. Hence, investors who have a high-risk appetite should opt for investing in small-cap funds.” One could consider allocating a small portion of his/her portfolio towards small-cap funds as it is highly volatile.

Some of the advantages of investing in small-cap funds include exponential growth potential, availability at a lower price, among others. As small-cap funds invest in companies that could flourish over time and become multi-baggers, industry experts say they offer tremendous growth potential.

New companies that are available at a lower price, small-cap funds usually invest in such companies, as they may be undervalued. As these funds focus on newer concepts and invest in companies that focus on disruptive technologies, they could attain a competitive advantage over rivals acquiring significant market share. In a bull run, experts say they could outperform mid-cap and large-cap funds.

Here are some factors one needs to consider before investing in small-cap funds;

The risk profile of the investor

Small-cap funds invest in stocks of companies that have short boom and bust cycles. Hence, these funds are only suitable for aggressive investors who knows when to enter and exit their holdings. Experts say this is the only instance when investors might have to time the markets to maximise their returns.

Checking track record

Checking the track record of a small-cap fund is necessary. During both bull and bear markets, experts say, investors should check the performance of small-cap funds. More so, during the bear market as it helps one measure and understands the downside protection against market falls.

Investing through the SIP route

Timing the markets is never the right approach with investments in stock and mutual fund. Without the proper knowledge, one could end up losing all their money while speculating and time timing the market. Hence, experts say investing in mutual funds through SIP helps avoid timing the market and averages their purchase cost in the long run.

However, note that for small-cap funds SIPs do not work, as timing is critical to get maximum returns with small-cap funds.

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