If you have just begun exploring mutual fund investing, you may have come across small-cap funds. These funds often appear promising thanks to their high-return potential, but are they the right place to begin your investment journey? Let us take a closer look at this article.
What Are Small Cap Funds?
Small cap mutual funds invest in companies ranked below the top 250 by market capitalization, the newer or less-established players in the market. These businesses are often in early growth phases and may operate in emerging sectors or underserved markets.
● Upside: Potential for capital appreciation.
● Downside: Higher volatility, limited liquidity, and unpredictable performance.
According to SEBI, anything beyond the 250th company by market cap is considered a small-cap stock. So, are they a good first investment? Here is where things need clarity.
While the high-growth narrative is tempting, small cap funds may not be ideal for first-time investors, as new investors are usually still learning how markets behave. A sharp 10% dip (even if temporary) can lead to panic and premature withdrawals. That is often how early mistakes happen.
Consider this: You invest ₹50,000 in a small cap fund, and within a few months, your investment drops to ₹40,000. Even if the fund has solid long-term prospects, seeing that kind of loss early on can shake your confidence.
This is why experts across the globe often recommend starting with:
● Large cap funds (for stability)
● Flexi cap funds (for balance)
● Or index funds (for passive exposure and lower costs)
Once you have weathered a few market cycles and are comfortable with volatility, adding small cap funds makes more sense.
Where Small Cap Funds Fit In?
Funds like DSP Small cap fund or other AMCs’ small cap funds can add meaningful value to a well-diversified portfolio.
They are best introduced after:
● You have set up a stable core portfolio with large/mid-cap or index funds.
● You understand how SIPs, compounding, and market corrections work.
● You have a long-term view of 7–10 years minimum.
In that case, small caps can be used to increase long-term returns, especially through SIPs that average out costs across market ups and downs.
To illustrate, consider Bajaj Finance, which started as a lesser-known player and is now a major name in the NBFC space. Investors who parked capital in Bajaj Finance a decade ago have seen their wealth grow considerably. In fact, it has delivered a CAGR of 32% over the past 10 years. But here is the key: That growth wasn’t linear. There were plenty of dips, corrections, and uncertainties along the way. The reward came to those who stayed invested. The same goes for all small cap stocks in which small cap funds invest in.
Risks You Shouldn’t Ignore
Before you go all in in small cap funds, be mindful of:
● Higher volatility: These funds can show big swings, both ways.
● Liquidity issues: Some underlying stocks may not be easy to exit in large volumes.
● Business risks: Younger companies can face regulatory or competitive challenges more frequently than large, established firms.
● Market sentiment: Small caps are often the first to fall when the market turns bearish.
Final Thoughts
Small cap funds can offer attractive returns, but the journey can be emotionally and financially bumpy, especially if you are just getting your feet wet.
A better approach is to start with stability. Build familiarity with the market through large cap or index funds. Learn how volatility works. Then, once you have gained confidence, you can gradually introduce small caps into your portfolio for that added growth boost.
When it comes to investing, the initial excitement of chasing quick gains often fades over time. What truly endures and delivers results is consistent investing backed by patience and discipline.
