What Are Small Cap Funds? (A Comprehensive Guide)

Have you ever blown up a balloon? Initially, it inflates rapidly but gradually the growth rate declines as it becomes significantly large. However, if there is a hole in the balloon it fails to grow. A similar principle applies to small-cap companies.

Small-cap mutual funds invest in small-cap companies (companies with a market cap of under ₹ 5000 crores). These funds are gaining popularity in the investment world. This article aims to provide you with valuable insights about small-cap funds.

what is a small-cap fund?

Companies or businesses can be categorised based on their market capitalization. Look at the list below.

Mutual funds that predominantly (at least 65%) invest in equity and equity-related instruments of small-cap companies are called small-cap mutual funds.

Small-cap mutual funds are considered high-risk & high-return investments. This is because of the potential for rapid growth as well as a higher level of volatility compared to large-cap or mid-cap funds.

Related Articles: Multi-Cap Funds | Flexi-Cap Fund | Equity Funds

Which small-cap fund is best?

The answer to this question may differ for different individuals as each investor is unique.

Based on past 5-year performances, here are some of the best-performing small-cap mutual funds in India.

Sidenote! Past performance must not be the only deciding factor. Investors should investigate other factors to choose the best mutual fund scheme that aligns with their goals.

how much to invest in a small-cap fund

Determining the ideal amount to invest in small-cap funds is challenging as it depends on various crucial factors, including:

1. Your financial goals
2. Risk tolerance level
3. Investment time horizon
4. Your age
5. The way you budget your finances
6. Your investing & diversification strategy

While evaluating these factors, personalized advice from a professional financial advisor can be beneficial.

Well, here below are some general tips that may help you a bit. Please note these are not financial advice.

1. These funds are not suitable for risk-averse investors so they should invest only a small percentage of their portfolio in small-cap funds
2. Small-cap mutual funds may show higher volatility in the short term which may impact short-term returns. Hence, these are not ideal for short-term investments.
3. Younger investors may have a longer time horizon and higher risk tolerance that could impact the allocation percentage to small-cap funds
4. Investors seeking further diversification and have a long-term vision may find small-cap funds appealing

how to invest in a small-cap fund

There are two ways to invest in any mutual fund- offline & online. Nowadays, most investors go with the online route as it offers more convenience. Here is how you can invest in small mutual funds online.

1. Choose an online investment platform
2. Open an investing or Demat account
3. Complete your KYC
4. Choose a small-cap mutual fund to invest
5. Decide the mode of investment SIP or lump sum
6. Make the payment
7. You are done
8. Review your investments periodically

Related Read: How to start SIP investment

Alternative Ways to Invest In Small Cap Companies

Let’s discuss some alternative ways to invest in small-cap companies other than small-cap mutual funds.

1. Small-cap Index Funds

A lot of asset management companies have launched their small-cap index funds. They are more cost-efficient than actively managed mutual funds due to their low expense ratios. Read here for a detailed guide on index funds.

2. Small-Cap ETFs

Small-cap ETFs (Exchange Traded Funds) are another good way to leverage the potential of small-cap companies. They are investment funds that hold a portfolio of assets.

3. Direct Investments

If you have a Demat account, you can directly invest in the stocks of small-cap companies. However, it requires good expertise & understanding of the market to generate significant returns.

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