5 Common Mistakes to Avoid When Investing in Small-Cap Mutual Funds

Small-cap mutual funds offer the potential for higher growth but also come with higher risk. Before you start investing in small-cap mutual funds, you must know some common mistakes investors make while investing in small cap funds.

In this article, we will cover the five common mistakes people make while investing in small-cap mutual funds. Let’s get started.

What are Small Cap Mutual Funds?

Small-cap funds are equity mutual funds that invest in small companies with growth potential. These companies are beyond the top 250 companies in terms of full market capitalisation.

Mistakes to Avoid When Investing in Small-Cap Mutual Funds

Here are the five common mistakes to avoid while investing in small-cap mutual funds in India:

Investing Only in Small-Cap Mutual Funds

Many investors invest only in small-cap mutual funds to earn higher returns, as the growth potential of these funds could be higher.  However, these funds also have an inherent higher risk than mid-cap and large-cap mutual funds.

You may invest one time or start a SIP (Systematic Investment Plan) in any small-cap mutual fund. But these funds face higher volatility depending on the market conditions.

For example, s mutual funds were impacted by the Covid 19 market crash and delivered lower returns to investors. The same happened during the Russia-Ukraine war in 2022, and the stock markets were seeing a huge downturn. Hence, investing in different categories of mutual funds with varying asset classes can help safeguard your portfolio from such instances.

Relying on the Past Performance

Relying solely on past performance can impact the returns because past returns do not guarantee future results. Small-cap mutual funds may yield high returns in a specific period because of the growth of the companies in which the mutual funds have invested. However, those companies may not yield the same returns every year.

Waiting for the Right Time to Start

Suppose you are a disciplined investor and invest a regular amount every month in SIP. In that case, ideally, you should not be timing the market and waiting for the right investment opportunity because an SIP is among the best options to invest in mutual funds. Let us understand this with an example:

Suppose you invest every month in a mutual fund in ABC Small Cap Mutual Fund, and you invest on the 1st of every month without seeing the market conditions, and you get different units every month based on NAV.

As you can see in the example above, you invest Rs. 1,000 regularly for four months, but you get different units every month, depending on the performance of the underlying stocks, which shows no one can predict in which month you will get less units and more in a particular month. Hence, while starting an SIP, you should not wait for the right time; instead, you should find a suitable mutual fund and start an SIP.

Not Investing When the Market Crashes / Corrects

Famous investor Warren Buffet once said ‘“Be fearful when others are greedy and greedy when others are fearful.” Typically, investors tend to stop investing when there is a downturn in the market; this can be due to changes in economic policy, announcements by the government, market correction, war, pandemic, etc.

Even if you are not able to invest a higher amount, you must invest the same monthly amount to average your returns in an SIP.

Investing Without Any Objective

Suppose you are a short-term investor and start investing in small-cap mutual funds you may lose your investment amount because small-cap mutual funds are not ideal for short-term investors as they are volatile.

Hence, before investing, you must know why you are investing, whether to buy a new car or for a child’s education and consider the time horizon you have for the investment. Invest in small-cap mutual funds if you do not mind taking a higher risk and have at least five years or more to stay invested.

Conclusion

Avoiding these five common mistakes can make you a smart mutual fund investor, and it is suggested that once you invest in a small cap mutual fund, you must review it thoroughly at least once a year to understand if it is meeting your financial goals. If required, you must consult advisor.

Frequently Asked Questions (FAQs)

Why should I include a Small-Cap Mutual Fund in my Portfolio?

Small-cap mutual funds can potentially give higher risk adjusted returns in the long term.

Who should invest in small-cap mutual funds?

Small-cap mutual funds are ideal for investors who do not mind taking higher risks, have a long-term investment horizon, and invest regularly.

How much should I invest in a small-cap mutual fund?

There is no rule for investing a specific percentage into small-cap mutual funds. But ideally, you can invest based on investment objective and risk appetite into small-cap mutual funds.

Above article is authored by Quantum.

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