Small-cap funds are highly volatile and carry high risk in the short term.
High-risk investors who want to earn high returns prefer investing in equity mutual funds. However, there are various sub-classes of equity mutual funds, namely large-, medium-, and small-cap funds, depending on their market capitalization. Over the last few years, small-cap mutual funds have become a popular investment choice. These funds are relatively riskier and volatile in the short term but can offer higher returns in the long term. However, investors should allocate an amount in small-cap mutual funds that aligns with their risk appetite, investment horizon, and financial goal.
If you are interested in investing in small-cap mutual funds, here is a quick guide for your aid:
What are small-cap mutual funds?
Small-cap mutual funds are equity mutual funds that invest a major portion (80%) of their assets in equity or equity-related securities of small-cap companies. A small-cap company has a market capitalization of less than Rs. 5,000 crores and ranks below the top 250 companies in terms of market capitalization.
Is it safe to invest a large sum in small-cap mutual funds?
Small-cap funds are highly volatile and carry high risk in the short term. However, they potentially offer high returns, in some cases, even triple up over a short period. In the last year, the top-performing small-cap mutual funds have generated over 100% returns. As per a June 2021 report, small-cap funds have offered returns of 105.31% in the last year.
Experts recommend investing a portion of your portfolio in small-cap funds but ensuring optimal diversification to reduce risk. If you have a considerably high-risk appetite, you can keep 10-15% of your equity portfolio in small-cap mutual funds.
What factors to consider before investing in small-cap mutual funds?
Investment risk: Even the best of small-cap mutual funds carry high risk but offer great returns. Hence, when selecting the small-cap funds, consider your risk appetite and see if it aligns with the chosen small-cap company portfolio.
Investment returns: Small-cap mutual funds have the potential to offer high returns, which can be a great addition to your portfolio. However, choose small-cap funds that have recorded consistent performance over the years and carry adequate risk per your risk appetite.
Investment cost: All mutual funds, including small-cap funds, have an expense ratio. These expenses ensure your mutual fund is well-managed. SEBI (Securities Exchange Board of India) limits the expense ratio at 2.50% of the fund value. Take into account the expense ratio of the mutual fund before making a decision.
Investment goals and horizon: Your investment goal and horizon significantly influence your investment. Particularly, in small-cap mutual funds, you should aim to invest for a longer duration to maximize returns and minimize risk. Short-term investments in small-cap mutual funds are subject to high volatility and risk.
Taxes: Mutual funds are taxed according to the investment duration. If you invest in small-cap mutual funds for less than one year, you will pay capital gain taxes at 15%. However, if you hold your small-cap investments for longer than one year, your capital gains will be taxed at 10% of the amount exceeding Rs. 1 lakh.
The sum you should invest in small-cap mutual funds depends on your risk appetite, financial goal, and investment horizon. It is advisable to maintain a diversified portfolio with distributed investments across different asset classes and sub-classes. Use the Tata capital Moneyfy App to manage and monitor your mutual funds and ensure your portfolio is optimally diversified.
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