What are Small Cap Mutual Funds?
Small-cap funds invest in stocks of smaller companies, typically outside the top 250 by market size. These companies are often less known in everyday life. While small-cap stocks have the potential for impressive returns, they are highly volatile, which means they can also experience significant losses over the short to medium term.
Advantages of Small Cap Funds
- Take advantage of early investments in companies with the potential to grow into major market players.
- High risk due to the companies' limited ability to cope with challenging market conditions.
- Best suited for aggressive investors with a long-term horizon of 7 years or more.
How Small Cap Mutual Funds Work
Small Cap Equity Funds are required to invest at least 65% of their assets in stocks of companies classified as small-cap. These small-cap companies are those with a market capitalization smaller than the 250 largest companies listed on the stock exchanges.
Since Small Cap Funds primarily invest in smaller companies, they have the potential to offer high returns. However, they are also highly volatile, as the performance of small-cap companies can be significantly affected by fluctuating market conditions. To mitigate the risks associated with this volatility, it’s recommended that investors allocate only a small portion of their portfolio to Small Cap Equity Funds.
Who Should Invest in Small Cap Funds?
For Investors Seeking Long-Term Capital Growth
Small Cap Funds are known for their short-term volatility, making them more suitable for investors with a long-term outlook, ideally those willing to stay invested for 7 years or more. Over extended periods, these funds have the potential to deliver significant returns that are hard to match. However, even in the long run, it’s recommended that investors limit their exposure to Small Cap Funds due to the inherent volatility of returns.
For Investors With a High Risk Tolerance
Small Cap Funds primarily target small, growing companies with high potential for rapid expansion. This focus offers the opportunity for exceptional returns. However, the smaller size and relative instability of these companies also introduce considerable risk, as their performance can be heavily affected by market fluctuations. Given their high-risk, high-reward nature, these funds are best suited for investors who have a strong appetite for risk.
Taxation on Small Cap Funds
Capital gains from the sale of Small-Cap Equity Fund units are taxed based on the investor’s holding period, which refers to how long the investor has held the units. Since these funds primarily invest in stocks, their tax treatment is consistent with that of other equity-based investments.
If the holding period is up to one year, the gains are classified as short-term capital gains (STCG) and are taxed at a rate of 15%. However, if the holding period exceeds one year, the gains are classified as long-term capital gains (LTCG). LTCG up to a specified limit is tax-free, while any amount exceeding that threshold is taxed at a rate of 10% on the excess.
How to Invest in Small Cap Funds
Investing in Small Cap funds is easy and can be done through platforms like World Fund. Here’s a simple guide to getting started:
- Sign up online: Register on the World Fund platform via their app or website.
- Select your fund: Go to the Mutual Funds section and choose the Small Cap fund you want to invest in.
- Choose your investment: Decide the amount you want to invest and select your investment method (SIP or lump sum). Complete your KYC: Submit your KYC details (like your ID and bank information) to finalize your investment.
By following these simple steps, you can start investing in some of the world’s top companies today.
Frequently Asked Questions
How long should I stay invested in Small Cap Mutual Funds?
Since Small Cap Funds are equity-based, meaning they invest in stocks of companies, it’s important to stay invested for a minimum of 5 years to fully benefit from their potential growth.
Where do Small Cap Mutual Funds invest?
By regulation, Small Cap Mutual Funds must allocate at least 65% of their investments in stocks of companies ranked 251 and lower based on market capitalization. While many funds in this category also invest in mid-cap stocks and, in some cases, a small portion in large-cap stocks, they are primarily focused on small-cap companies. As a result, these funds inherently carry the risk and potential rewards typical of small-cap investing.
How Risky Are Small Cap Mutual Funds?
Small Cap Mutual Funds invest in equities, which can lead to volatility in the short term. However, over the long term, the risk tends to decrease significantly.
What Returns Can I expect?
Should I Invest in Mid Cap Funds?
Mid Cap Funds provide an opportunity to invest in potential future industry leaders. Many of today’s largest companies started out as mid caps. These companies often experience rapid growth as they work towards becoming market leaders. However, not all mid-cap companies will make that leap to becoming major players.
Additionally, because they are still in the growth phase, they can face challenges during tough market conditions. Investing in these funds can yield significant rewards, but it’s important to be prepared for fluctuations in returns over the short to medium term.
