Should You Invest In Small-Cap Mutual Funds in 2021

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Investors are flocking to buy small-cap mutual funds in India in current times. Small-cap funds have the power to give huge returns, of as good as, close to 100%. Read on to find out why you must invest in small-cap mutual funds in 2021.

What are small-cap mutual funds?

Small-cap mutual funds are open-ended equity schemes that predominantly invest in small-cap stocks. Small-cap stocks are from small-sized companies that have a high risk and high return profile.

As per SEBI, small-cap mutual funds in India invest in small companies beyond the top 250 companies in market capitalization. Small-sized companies are mostly unheard of in our daily lives and can deliver amazing returns. But at the same time, small-cap companies are highly volatile.

Small-sized companies are young and want to expand aggressively, so they are highly volatile and more vulnerable to losses during market slumps.

How small-cap mutual funds work

Fund composition plays an important role. Small-cap mutual funds make a minimum investment of 65% of their total assets in equity and equity-related instruments of small-cap companies. Most small-cap mutual fund schemes also allocate to mid-caps and large-cap stocks. Despite these, as the funds are always small-cap heavy, they carry the risk-reward mix linked with small-cap investing.

Over 65% of investment in small-cap stocks gives you an edge over institutional investor. Institutional investors prefer to purchase large-cap stocks for their stability. And investors hoping for aggressive returns buy small-cap funds, either online or offline.

Features of small-cap mutual funds

Below are some of the top features of small-cap mutual funds in India:

• Investors benefit from investing early in the companies that can be top businesses of the future
• Small-cap funds are ideal for aggressive investors with an investment horizon of around 10 years
• When you buy small-cap funds, online or offline, there is a high exposure to risk because of the small companies' lack of financial strength to survive harsh market conditions

Are small-cap mutual funds right for you?

The small-cap mutual fund category is right for you if you have an aggressive profile and an investment horizon of 10 or more years.

If you can stomach higher risks, you can consider investing in small-cap mutual funds. That said, you must have at least a small composition of your portfolio allocated towards small-cap funds.

Avoiding investing in small-cap funds is not a prudent way to deal with it. In doing that, you might keep yourself from enjoying the magical return generating potential of small-cap funds.

Know that small-cap funds can be highly volatile in the short run, especially when market conditions are unfavorable. But, if you stay invested for long, the returns can be market-beating.

Also, you must have a high level of patience while dealing with these types of funds. Prolonged periods of volatility or sharp falls may test your patience, but you must continue with your investments to create wealth over the longer term.

Things to consider while investing in small-cap mutual funds

Below are the top things to consider while investing in small-cap mutual funds:

1. Small-cap mutual funds are more volatile as compared to large-cap and mid-cap mutual funds. When markets experience a downfall, small-cap funds suffer the maximum as they are less intense and tend to move out of the business. Alternatively, small-cap funds are a great investment avenue for aggressive investors with high-risk capacity.
2. To allow the small-cap fund to generate returns per your expectations, you must stay invested for the long term.
3. In the last two years, the market has seen the small-cap category perform well. As a result, the type has attracted many investors and their money.

Why are small-cap mutual funds getting popular in 2021?

Many small-cap funds have offered on average a return of over 100% in one year. And so, these schemes are getting much attention.

Small-cap mutual funds saw a rally in the final quarter of 2020, which provided investors with huge returns. And that is the reason why the investors have flocked to them.

Should you invest in small-cap mutual funds in 2021?

Unlike the years 2018 and 2019, when only a few small-cap stocks rallied, the market saw an upswing in the stocks of small-cap companies from 2020.

Talking about the future, in the next few years, the government policies like production-linked incentives and focusing on infrastructure must ensure that economic growth is broad-based. This should help small-cap companies post good profit growth.

Also, with the incremental investments by investors and rising stock prices, you must invest in small-cap mutual funds in 2021.

Conclusion

Small-cap mutual fund schemes can offer superior returns over long periods. The reason is that the small-cap schemes usually bet on small companies with very high growth potential.

And when a small company becomes a vast company, its shares appreciate multiple times. Thus, small-cap stocks can be the desirable multi-baggers that every investor dreams of owning.