Invest in small cap funds like a pro: When, why and how to get started

Investing in small-cap funds can be a powerful strategy for long-term wealth creation—if you understand well when, why and how to invest wisely. Small-cap funds basically focus on companies with smaller market capitalisation. They offer great growth potential but also come with increased volatility. Here is how you can approach them like a pro.

What are small-cap funds?

Small-cap funds are a mutual fund category that invest in companies ranked 251st and below in terms of market capitalisation. Such businesses are smaller in size, newer, and often operate in niche sectors. They usually have a market cap of less than ₹5,000 crore.

As per Securities and Exchange Board of India (SEBI) regulations, small-cap funds must invest at least 65% of their assets in small-cap stocks.

Why invest in small-cap funds?

Small-cap companies have scope to grow. This means they have the potential to deliver higher returns as compared to large or mid-cap firms over the long term. Such funds often include promising startups or expanding businesses—offering retail investors a good chance to discover “hidden gems” before they become mainstream.

As small-cap funds invest in a wide variety of companies, the risk is disseminated across sectors. This lowers overexposure to any single business.

When to invest in small-cap funds?

Because of their volatility, small-cap funds are best suited for long-term investors—ideally those who can stay invested for at least five to 10 years. This time frame gives small companies enough time to grow and allows the market to recover from short-term fluctuations.

If you can remain patient through market ups and downs, small-cap funds can be a valuable part of your equity portfolio. They are also a good option after market corrections, when valuations become more attractive and growth potential improves.

How to invest in small-cap funds?

Here’s how to get started:

• Conduct your research: Look out for small-cap funds with a robust performance history, experienced fund managers and diversified portfolios. Assess their previous returns, expense ratio and current holdings.
• Start with Systematic Investment Plans (SIPs): An SIP permits you to invest a fixed amount periodically—monthly or quarterly. This approach averages out your cost over long time and helps you manage market volatility while building investment discipline.
• Diversify wisely: Do not allocate your entire equity investment to small-cap funds. Make sure, you combine them with large-cap and mid-cap funds. Doing so allows to maintain a balanced risk-reward ratio.
• Track performance periodically: Assess your fund’s progress but avoid reacting to any short-term market swings. Stick to your long-term investment goals.

Key concerns and risks

Before investing in small-cap funds, keep the following risks in mind:

• High volatility: Small-cap funds can fluctuate sharply, so short-term losses are common. Be prepared for market ups and downs.
• Liquidity issues: Small companies may have lower trading volumes, making it difficult for fund managers to buy or sell large amounts quickly.
• Fund manager dependency: The success of a small-cap fund often depends on the manager’s ability to pick quality stocks and manage risk effectively.

Conclusion

To invest in small-cap funds like a pro, focus on long-term goals, use SIPs to build consistency, and maintain a well-diversified portfolio. With patience, discipline, and the right research, small-cap mutual funds can be a valuable financial product in your investment journey—offering you the chance to benefit from the growth of tomorrow’s market leaders.