Wondering if you should deploy investments in small cap funds? Mutual fund firms mostly aim at maximizing investor returns and wealth through deploying capital in various securities. Based on the tolerance for risks at an individual investor level, these choose investments in either equity or debt funds.
Making investments in equity-based securities basically equates to investments made in stocks of several organizations. Investors should focus on the balance between risks and rewards while investing in small cap funds. Some of the aspects that you should carefully note include the associated risks, returns generated by the fund, future growth potential of stocks and benefits of diversification.
Here are some of the key things to remember before making investments in the best small cap funds.
- Returns – Small cap funds may usually surpass the performance of large and mid cap funds over the long haul. It has been seen that they may perform quite well if the market remains bullish.
- Risks – An element of risk is always present when it comes to investing in small cap mutual funds since they are affected by market volatility. They have a higher tradeoff between returns and risks, making them absolutely ideal for those who have a higher appetite for risks. Investing in small cap securities should be done with a long-term horizon and any fall/rise in prices owing to market fluctuations will ultimately be evened out.
- Growth – Investing in funds like for example Nippon small cap fund or similar funds may be a good strategy for portfolio growth. This investment may have the ability for shoring up growth levels in comparison to large cap stocks which may have already touched their peak levels.
- Diversification- The advantage of investing in mutual funds is always the capability of portfolio diversification. Through investments made in small cap funds, a finer balance may be achieved between returns and risks along with enabling diversification of the portfolio for lowering risks.
Strategies To Be Followed For Small Cap Investments:
If you are thinking of investing in the banking sector small cap funds like HDFC small cap funds or similar offerings, you should always keep a few strategic aspects in mind. These include the following:
- Fund Composition – There are various small cap entities present in the industry and investors have to obtain extensive knowledge of the market and long-term return prospects prior to deploying any investment. The fund composition will make a major difference in the nature of the portfolio.
- Investment Goals – Outline your financial blueprint for the long haul prior to deploying your investment. On the basis of the same, you can choose investments in small cap funds for accomplishing goals in the long haul. For getting aggressive returns over a shorter time period, this investment avenue is avoidable.
- Long-term Investments – The key towards ensuring higher returns via equity is staying invested for a longer duration. Investors should always remember that it is not possible to optimize wealth creation and they will have to stay invested in these funds for a period of 7-10 years. This will make sure that market fluctuations do not affect overall returns while volatility levels are smoothened out considerably.
- Patience – With midcap and Smallcap stocks, you should always remain patient with regard to the investment duration. The portfolio will not grow exponentially in just a year’s time and you should not face undue stress regarding the same. It will require a minimum time period of 3-4 years for the fund to achieve sufficient growth. Patience is a key virtue in this case.
- Quality – Take a quality-first approach when selecting stocks for investments. Many times, investors attempt at leveraging market cycles perfectly while investing in stocks with lower valuations. However, this may compromise the value of the whole investment. Select high-quality stocks that have done well previously and have ample future growth potential.
- Risks – Investors should analyze risk tolerance/appetite prior to taking investment decisions. Investors with higher risk appetite should select these funds. Others should refrain from choosing them.
- Performance – Make your investment only after scrutinizing the past performance of the small cap fund in question. Always check the performance across both bearish and bullish cycles in the market.
Taxation Aspects That You Need To Be Aware Of:
Returns arising from small cap funds are subjected to capital gains taxes (if any capital gains arise) along with DDT (dividend distribution tax) which applies in case any dividends are received. DDT is to be deducted by the mutual fund house at the rate of 10%. Capital gains refer to profits which are generated from selling investments. As a result, when you redeem small cap fund units and earn profits, you will be liable to pay capital gains taxes. The rate of taxation will be dependent on the tenure for which you remained invested in the mutual fund plan/scheme. This is known as the holding period.
If you remained invested in small cap funds for a holding period lower than a year, then capital gains that you earn will be called STCG (short term capital gain). This tax rate is 15%. If you stay invested in your small cap fund for a holding period exceeding 1 year, then the gains that you earn will be LTCG (long term capital gain). The tax rate is 10% in this category in case your gains surpass an amount of Rs. 1 lakh. These are factors that you have to keep in mind before investing.