Large Vs Small-Cap Mutual Funds: How to decide which works best for you?

December 05, 2020 11:49 AM

Should you go with the large-cap mutual funds or the small-cap ones? Let’s analyze both of them to find out what works the best for you.

Large-cap Fund Category, SEBI definition of large-cap, large cap, mutual funds, equity, market-capWith at least 80 per cent of money invested in the top 100 companies makes it a popular category among investors.

After watching all of the high-voltage action from distance, you’ve finally decided to step into the game of capital markets. You’re surely fascinated by the lure of the stocks. Well, who wouldn’t, especially when both Nifty and Sensex have delivered returns worth the previous three years in the past seven months? However, you decide to take it slow and begin with Mutual Fund investments.

To begin with, it’s a life-changing decision that you’ve just made. Stock markets – even after the worst of economic downturns – have offered multifold returns to their investors all across the globe. Even when the markets have virtually melted, they have always come out stronger than before. So, any investment in them is pegged to clock positive returns, more so today, when the vaccine euphoria signals a massive growth opportunity ahead.

Nevertheless, capital markets involve a number game in which if you haven’t made your calculations right, you can also end up on the other side of the fence. Short-term investors can lose their money and long-term investors might not make as good returns as they could’ve. So, it is always best to keep your strategy straight right from the start. It brings us to the perennial question: should you go with the large-cap funds or the small-cap ones? Let’s analyze both of them to find out what works the best for you.

There are a few factors that you must consider while choosing either of the two. They are as follows:

Risk Appetite: Large-cap funds are relatively stable and involve low risk. They comprise blue-chip stocks that perform well and have favorable prospects in the future. However, it also limits their growth potential in terms of percentage points. Small-cap funds, on the other hand, offer superior returns vis-à-vis their larger counterparts. This return obviously comes at a price. They are more volatile and sensitive to market dynamics. Small-cap companies also have a lower financial buffer than large organizations and hence, have higher exposure to risks. You must assess your risk tolerance level before zeroing in on either of the two.

Investment Goal: Another factor to consider is how long you intend to stay invested. The ideal investment horizon for the small-cap category is at least 5 years. It ensures that even if the market dynamics make you incur losses for a year or two, they can be easily covered later owing to the cyclic nature of the market and fund reallocation by the MF house. But if you want consistent returns and decide not to go for the long haul, the large cap is going to be your cup of tea.

The Right Mix: Perhaps, it should never be a question of choosing between large-cap and small-cap funds. Why not invest in both of them and enjoy the best of both worlds? At least, it is what seasoned investors do for their long-term and short-term investment needs. Every asset class and mutual fund category has certain advantages and disadvantages. You should go for a balanced mix considering your financial goals. Even if you are determined to tap certain aspects of a category, you can always give higher weightage to the same in your portfolio. Large-cap funds can be your anchor with small-cap funds acting as the primary growth driver.

In a nutshell, you are the investor. You’re aware of everything from your risk appetite to your financial goals and even the capital allocation. Make an informed investment decision. Godspeed!

(By Pranjal Kamra, CEO, Finology)

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