Is it the right time to invest in small-cap funds?

In the past few years, small-cap mutual fund investment has acquired great acceptance in the investing vertical. Small-cap funds have provided more than satisfactory returns, which has grabbed the attention of many investors. However, as such funds are market-linked, they are subject to volatility and may face a tougher time than large-cap and mid-cap equity funds when the markets are rough.

So, the question is, if you have a good chunk of equity investment already present in your investment portfolio in the form of mid-cap, multi-cap, and large-cap funds, is it a wise decision to invest in a small-cap fund? Are they lucrative investments? Can they deliver high returns over the long run? Let’s find out.

What is a small-cap mutual fund?

A small cap mutual fund invests in companies that rank over 250 on stock exchanges based on market capitalisation. As per the Securities and Exchange Board of India (SEBI), small-cap mutual funds must invest at least 65% of their assets in small-cap companies. Small-cap companies are those companies, which are in their earlier stages of growth.

Small-cap mutual fund investments may perform exceedingly well during a bull market. However, these funds may go through some tough market scenarios, which may result in an abrupt fall in returns. You must practice caution while investing in such funds. Invest in them only if you can undertake the risk involved in them and you are patient to remain invested for a long investment horizon.

Factors to consider before investing in a small-cap fund

Before you make the investment decision, you must plan out your financial goal and the investment duration you want to remain invested for and consider your risk appetite. Read on to know certain factors you must consider when investing in small-cap mutual funds:

  • Capital appreciation

You can invest in small-cap mutual funds if you are looking for considerable capital appreciation. Small-cap mutual funds concentrate on growth opportunities and aim to create valuable assets. Including small-cap mutual funds in your portfolio may not just diversify your portfolio but even balance it out. Suppose your investments in large-cap mutual funds are not providing you adequate returns according to your expectations, then small-cap mutual funds might help with that.

  • Long-term investment

A small-cap mutual fund is suitable for you if you have a long-term investment time frame of at least five to seven years. Note that small-cap funds have great potential and apply aggressive expansion strategies to gain returns. However, they may take time to gain their value. So, you must remain invested in small-cap funds for a longer investment duration to make the most out of it.

  • High-risk appetite

Small-cap mutual funds are suited for you if you have a high-risk appetite because such funds are susceptible to volatility in the market. As such funds hold higher risk, they provide you with the opportunity to earn higher returns too. However, they lack the financial strength as well as organisational stability that is present in large-cap stocks to tackle market downturns. Thus, small-cap mutual funds are highly volatile and not the best option if you are a risk-averse investor.

Summing up

There’s no specific right time to invest in small-cap mutual funds. You can begin with your investment in a small-cap mutual fund anytime. However, you must invest in alignment with your investment goals to meet them. Small-cap mutual funds may be a good choice for you if you understand the risk linked with them and can remain invested for a long time, say five to seven years. You can also consider opting for the Systematic Investment Plan (SIP) route when investing in small-cap funds. This will help hedge market volatility and average out the cost of your investment over time.