To simplify things for investors, mutual fund companies often group their funds based on company size. There are three major kinds – small-cap, mid-cap, and large-cap.
Being aware of these distinct fund types is essential for making prudent investment decisions. Covered here are the significance of small-cap funds along with their benefits and associated risks.
What exactly are small-cap mutual funds?
Small-cap companies are the ones that rank beyond the top 250. Small-cap mutual funds are like a group of investors pooling their money to invest in these smaller companies.
The upsides of putting money in small-cap mutual funds
Before delving into the risks of small-cap mutual funds, let’s first understand the benefits they bring to the table –
Potential for outstanding returns
Small-cap mutual funds can potentially provide significantly higher returns compared to larger funds. This is because smaller companies have room to grow rapidly.
Affordable investment entry
The expense of a small-cap fund unit (known as NAV or net asset value) is generally lower. This infers you can purchase more units with the same investment, potentially reaping higher rewards during favourable market conditions.
Spread your risk wisely
Investing in small-cap funds permits you to diversify your portfolio. This diversification shields you from thorough market downturns, allowing you to protect your investments even during tough times.
Recognising the hazards linked to small-cap mutual funds
Despite their perks, small-cap mutual funds do come with risks that investors need to be aware of. Let’s skim through a few of these risks –
Liquidity concerns
Large institutional investors do not usually invest in small-cap mutual funds. Even individual retail investors might not participate heavily. This can create liquidity problems, making it more challenging to buy or sell fund units.
To tackle liquidity challenges, it is advisable to invest with a long-term perspective. This lowers the requirement for constant purchasing and selling, making liquidity problems less impactful. Moreover, remaining updated with your mutual fund’s liquidity status as well as market trends can assist you time your transactions effectively.
Volatility
This is a notable risk for small-cap funds. Funds’ value swing wildly, making them come across as a risky investment. So, losses could be considerable if prices do not go as anticipated.
To counter this, consider opting for buy and hold strategy. Holding your investments through market movements can assist balance out the market’s ups and downs over the short term. Diversification is the next crucial strategy, which means disseminating your investment throughout distinct fund types and sectors that can cushion the effect of volatility on your investment portfolio.
Variable performance
Small-cap fund’s performance depends on specific factors such as the selection as well as the performance of the stocks selected and the decision of the fund manager. Owing to such factors, the funds may not perform as impressively as you may anticipate.
To counter this variability in fund performance, ensure to research and choose funds with skilled and experienced fund managers. Their expertise in the selection of stocks and decision-making can considerably increase the performance of the fund.
Conclusion
Investing in small-cap funds can be beneficial if you factor in the potential rewards they provide. However, ensure to understand the risks associated with small-cap mutual funds.
Make sure to invest with a long-term vision. This can play an essential part in lowering the risks tied to small-cap investments as the market’s fluctuation tends to smooth out over the long term. While the potential of generating high returns is appealing, balancing your investment portfolio with different fund types can even offer high stability. So, acknowledge the risks, and make investment choices that align with your life goals and risk appetite to earn substantial returns.