If you often rely on historical returns before making an investing decision, it is natural for you to get tempted by small cap or mid cap mutual funds over their larger counterparts.
So, should a small investor place a higher bet on small cap mutual funds in order to earn high returns? Investment advisors caution investors from investing too much money in the small caps. The reasons are simple: They are highly volatile and deliver unpredictable returns.
There are 24 small cap mutual funds with total assets under management (AUMs) amounting to ₹1,68,434 crore as on June 30, 2023.
The average returns of small cap funds in the past one year were 24.62 percent, and 39.43 percent for the past three years and 18.55 percent in the past 5 years, shows Morning Star data as on Aug 3, 2023.
(Source: Morning Star; as on Aug 3, 2023)
Key factors to consider
Risky: They are extremely risky and volatile in nature. The net asset value (NAV) of small cap funds fluctuates within a wide range.
Short term: If you are investing for a short duration, then short term mutual funds are definitely not meant for you. So, these funds are meant for investors who want to invest in the long run.
New investor: Sometimes, investors who are new to mutual funds get carried away with the high performance delivered by small-cap mutual funds – something which should be avoided. So, if you are new to investing, you should refrain from investing in small cap mutual funds, say wealth advisors.
“We often tell our clients to first get their feet wet with index and large cap funds. And it’s only after dabbling in larger funds for some time, one should explore small cap mutual funds,” says Deepak Aggarwal, a Delhi-based financial advisor.
Should you invest in them?
Financial advisors usually do not suggest investors allocate more than 10-15 percent of their portfolio to small cap mutual funds.
However, if your risk appetite is too high, then you can allocate a higher amount.
“Some investors look at the historical returns of small cap funds and decide to invest based on that. It is not fair since the high returns posted by small cap mutual funds arise out of the highly volatile nature of small cap mutual funds,” said Sridharan S, founder of Wealth Ladder Direct.
To sum up, small cap mutual funds are risky and volatile, and one should invest in these schemes only for a long duration and only a small part of their portfolio.