Small cap funds vs. large cap funds: Which is better?

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Most experts agree that investing in mutual funds is a smart move for those who want to grow their wealth and safeguard their financial future. From diversification and professional management to relatively low costs and easy liquidity, a mutual fund investment caters to different investors with different goals and risk tolerance. But when it comes to choosing a strategy, should you go with small-cap funds for high risk and high rewards or large-cap funds for stability but less risk?

Both come with their own advantages and disadvantages and depending on your investment goals, one may be more suitable than the other.

Here are some crucial pointers that can help you understand which one or both suit you better in terms of liquidity, risk profile, growth potential, and time frame, among other factors. 

  • Risk

A small cap fund invests in stocks of companies with a market capitalization of less than 5,000 crores, while a large-cap fund invests in stocks of top 100 companies listed on stock exchange by market capitalization having a market cap of Rs. 20,000 crore or more. Thus, small-cap funds typically carry higher risks as they invest in companies in their early stages, which could be vulnerable to volatile markets.

Large-cap funds invest in top-ranked, stable, and dominant companies with strong cash flows, diversified operations, high revenue, etc., therefore being less prone to market volatility.

  • Growth potential and returns

Small-cap funds usually have higher growth potential than large-cap funds. The growth potential of these mutual fund schemes is linked to the fact that small companies have more room for growth and expansion, which could translate to higher returns for investors. It is recommended to invest in small cap funds if you can handle volatility and risk to earn high returns.

Large-cap companies are already established, have a broader customer base, and have built strong brands. They have already matured and grown considerably. Hence returns are more stable but may not be as high.

  • Liquidity

During market or economic downturns, small-cap companies may suffer more than large-cap companies. This is because small-cap companies may struggle to maintain their profitability or may have a harder time accessing necessary funds due to their size. As such, there may be fewer buyers during market volatility, a significant hurdle to selling your shares.

Large-cap companies may be able to weather market crashes better due to their established size and financial stability.

  • Diverse range of industries

The industries in which small-cap funds invest tend to be more diverse. These companies often offer innovative products or services that are new to the market and are still largely unknown but have the potential to grow significantly over time. This gives investors an opportunity to get involved early on before they become more established.

Large-cap funds typically invest in larger companies with a proven track record and widely distributed products or services, which means less risk for investors but also potentially lower returns.

So, small cap funds vs. large cap funds: Where to invest?           

The decision between small cap and large cap funds ultimately comes down to individual preferences and goals. However, rather than considering them as an either/or option, including both for a well-rounded portfolio and diversification may be beneficial.

Remember that in both investments, you need to stay for the long term. One way to ensure a disciplined long-term approach is to implement an SIP (systematic investment plan) in both funds. Make sure you use an SIP calculator beforehand to compare different mutual fund plans, understand their projected returns, and allocate an appropriate amount regularly to achieve your goals.

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