Small cap mutual funds are equity mutual funds that mainly invest in small-cap companies. These companies are usually smaller than large-cap and mid-cap companies, but they may have strong growth potential.
Small cap funds can give good returns over the long term, but they also carry higher risk. Their value can move up and down sharply in the short term. That is why these funds are more suitable for investors who can stay invested for many years and handle market volatility.
If you are new to mutual fund investing, you can also read our beginner guide on benefits of SIP investment.
What Are Small Cap Mutual Funds?
Small cap mutual funds are mutual fund schemes that invest mostly in small-cap companies. These are companies that are smaller in size compared to large and mid-sized companies.
As per mutual fund categorisation rules, small cap funds invest at least 65% of their total assets in equity and equity-related securities of small-cap companies.
In simple words, when you invest in a small cap mutual fund, your money is invested in a group of smaller listed companies. These companies may grow faster in the future, but they can also be more risky than large established companies.
Meaning of Small Cap Companies
Small cap companies are smaller listed companies in the stock market. They are usually outside the top large-cap and mid-cap companies by market capitalisation.
These companies may be in the early or growing stage of business. Some of them can become bigger over time, but not every small company becomes successful.
Small cap companies can grow fast, but they may also face more business pressure during weak market conditions. This is the main reason small cap mutual funds are considered high-risk investments.
How Small Cap Mutual Funds Work
A small cap mutual fund collects money from many investors. The fund manager then invests this money mainly in small-cap stocks.
The fund manager studies different companies before investing. They may check:
- Business growth
- Company profits
- Management quality
- Debt level
- Future potential
- Market valuation
- Industry condition
The value of the fund goes up or down based on the performance of the companies in its portfolio. If the selected companies perform well, the fund value may rise. If the market falls or companies perform badly, the fund value may decline.
Key Features of Small Cap Mutual Funds
Small cap mutual funds have some important features that every investor should understand.
- They mainly invest in small-cap companies.
- They are equity mutual funds.
- They have high growth potential.
- They also have high market risk.
- They can be very volatile in the short term.
- They are more suitable for long-term investors.
- Fund manager selection plays an important role.
- SIP can be a better way to invest for many beginners.
These funds are not designed for quick returns. They need patience and a long investment period.
Benefits of Small Cap Mutual Funds
Small cap mutual funds can be useful for investors who want long-term growth and are ready to take higher risk.
High Growth Potential
Small-cap companies may grow faster than large companies if their business performs well. This gives small cap funds the potential to create strong long-term wealth.
Diversification
Instead of buying one small-cap stock, a small cap mutual fund invests in many small-cap companies. This reduces the risk of depending on only one company.
Professional Fund Management
A fund manager handles stock selection and portfolio decisions. This is helpful for investors who do not have enough time or knowledge to research small-cap stocks directly.
SIP Option
Investors can invest through SIP. SIP helps invest a fixed amount regularly and reduces the pressure of timing the market. You can understand this better in our guide on benefits of SIP investment.
Long-Term Wealth Creation
Small cap funds can be useful for long-term goals if the investor can stay invested through market ups and downs.
Risks of Small Cap Mutual Funds
Small cap mutual funds are not risk-free. They can fall sharply during market corrections.
Important risks include:
- High volatility
- Sharp short-term losses
- Liquidity risk in small-cap stocks
- Business failure risk
- Higher impact of market downturns
- Negative returns in some periods
- Higher dependence on fund manager decisions
Small cap funds are not suitable for investors who panic when the market falls. They are also not good for short-term goals.
Small Cap vs Mid Cap vs Large Cap Mutual Funds
| Fund Type | Invests Mainly In | Risk Level | Suitable For |
|---|---|---|---|
| Large Cap Funds | Large companies | Lower than mid and small cap | Investors seeking stable equity exposure |
| Mid Cap Funds | Medium-sized companies | Moderate to high | Investors looking for growth with risk |
| Small Cap Funds | Small companies | High | Long-term investors with high risk appetite |
Large cap funds are generally more stable. Mid cap funds offer a balance of growth and risk. Small cap funds have higher growth potential but also higher risk.
Who Should Invest in Small Cap Mutual Funds?
Small cap mutual funds may be suitable for:
- Investors with high risk appetite
- Long-term investors
- People who can stay invested for 7 years or more
- Investors who already have basic investments in large-cap, flexi-cap, or index funds
- People who can handle short-term losses
- SIP investors looking for long-term growth
These funds should be a part of your portfolio, not your entire portfolio.
Who Should Avoid Small Cap Mutual Funds?
Small cap mutual funds may not be suitable for:
- Low-risk investors
- Short-term investors
- People investing emergency money
- Investors with goals within 1 to 3 years
- Beginners who do not understand market risk
- People who panic during market falls
If your main goal is safety, small cap funds may not be the right choice.
How to Invest in Small Cap Mutual Funds
You can invest in small cap mutual funds online through an AMC website, mutual fund platform, broker app, or investment advisor.
Before investing, follow these steps:
- Decide your financial goal.
- Check your investment time period.
- Understand your risk appetite.
- Compare different small cap funds.
- Check long-term performance, not only 1-year returns.
- Review expense ratio and fund manager experience.
- Start with SIP if you are a beginner.
- Review your investment once or twice a year.
Do not invest only because a fund has given high recent returns. Past returns do not guarantee future returns.
If you are planning to invest every month, you can also read how to change SIP amount to understand how SIP flexibility works.
Things to Check Before Choosing a Small Cap Fund
Before selecting a small cap mutual fund, check these points:
- 5-year and 7-year performance
- Performance during market falls
- Expense ratio
- Fund manager experience
- Portfolio diversification
- AUM size
- Riskometer
- Exit load
- Direct or regular plan
- Your own risk capacity
Expense ratio affects your long-term returns, so you should understand what mutual fund expense ratio means before choosing a fund.
You should also know the difference between direct and regular mutual funds because it can affect your investment cost.
A good small cap fund should not be judged only by short-term returns. You should check how it performs in both good and bad market conditions.
Are Small Cap Mutual Funds Good for Beginners?
Small cap mutual funds can be good for beginners only if they understand the risk clearly.
A beginner should not put all money into small cap funds. It is better to start with a small SIP and keep a long-term view. Beginners should also consider having basic exposure to large-cap, flexi-cap, or index funds before taking high exposure to small cap funds.
Small cap funds can create wealth, but they need patience.
Tax on Small Cap Mutual Funds
Small cap mutual funds are equity mutual funds. Their tax treatment depends on the holding period.
If you sell units within 12 months, gains are treated as short-term capital gains. If you sell units after 12 months, gains are treated as long-term capital gains.
Tax rules may change over time, so investors should always check the latest tax rules before redeeming their mutual fund units.
Conclusion
Small cap mutual funds are equity funds that invest mainly in small-cap companies. They can offer high growth potential, but they also come with high risk and volatility.
These funds are more suitable for long-term investors who can stay invested for many years and handle market ups and downs. If you are a beginner, start carefully, invest through SIP, and avoid putting all your money into small cap funds.
Small cap mutual funds can be useful for wealth creation, but only when they match your goal, time horizon, and risk appetite.
FAQs Small Cap Mutual Funds
What are small cap mutual funds in simple words?
Small cap mutual funds are equity mutual funds that invest mainly in small companies listed in the stock market. These companies may grow faster but can also be more risky.
Are small cap mutual funds risky?
Yes, small cap mutual funds are high-risk funds. Their value can fall sharply during market corrections, so they are better for long-term investors.
Are small cap mutual funds good for SIP?
Yes, SIP can be a good way to invest in small cap mutual funds because it helps invest regularly and reduces the pressure of timing the market.
How long should I invest in small cap mutual funds?
Small cap mutual funds are better for long-term goals. Investors should ideally have an investment horizon of 7 years or more.
Can beginners invest in small cap mutual funds?
Yes, beginners can invest, but they should start with a small amount and understand the risk first. They should not invest all their money in small cap funds.
Which is better, small cap or large cap mutual fund?
Large cap funds are generally more stable, while small cap funds have higher growth potential and higher risk. The better option depends on your risk appetite and investment goal.
Can small cap mutual funds give negative returns?
Yes, small cap mutual funds can give negative returns, especially in the short term or during market corrections.
Who should avoid small cap mutual funds?
Investors with low risk appetite, short-term goals, or emergency money should avoid small cap mutual funds.
