Every investor looks for that rare opportunity, i.e., finding a company with strong potential before the market fully recognises its value. Small-cap funds offer exactly that. Small-cap funds are mutual funds that invest in firms with comaparatively smaller market capitalisation, usually up to ₹5,000 crore. These firms are in growth phases and engage in niche industries with high expansion potential.
Although small-cap funds are more volatile compared to mid-cap and large-cap funds, they have the potential for high capital appreciation in the long run. Take a look at the key features of small-cap funds that have helped long-term investors achieve millionaire status over the years.
Historical performance
The past performance of small-cap funds has been amazing for those investors who held on during market cycles. For example, as per 2024 data, these funds delivered an average return of approximately 30.62% over the previous 5 years and around 20.45% over a 10-year period. Such returns show the long-term wealth-building power of small-cap investments when patience and discipline are followed.
Wealth creation through discipline
The millionaires created by small-cap funds did not become wealthy by timing the market but by being patient and focusing on long-term investments. Most employ the Systematic Investment Plan (SIP) method, i.e., investing a fixed amount at regular intervals despite market conditions. This technique smooths out market fluctuation and helps create large wealth in the long term.
For example, if you invest ₹10,000 per month in a small-cap fund with a 13% return rate per annum, you would end up with approximately ₹1 crore in 20 years. The power of compounding, along with regular investing, can make an average investor a millionaire.
Investment strategies you can follow for small-cap funds
Every type of investment requires you to formulate strategies before investing. Here are some strategies for small-cap investments:
- SIP approach
The SIP route is effective for investments in small-cap funds. Through regular investment, investors get the advantage of rupee-cost averaging while maintaining investment discipline. Most fund houses accept SIP investments starting from ₹500, and this helps investors gradually accumulate wealth.
- Long-term approach
Small-cap funds need a longer holding period because they can be volatile in the short term. The best returns are usually achieved over 10-year time frames, giving small companies time to mature and the market a chance to even out fluctuations.
- Understand the risks involved
Although there is potential for high returns, small-cap funds are synonymous with risks, including:
- Volatility: The funds can experience sharp short-term fluctuations.
- Liquidity risk: Certain small-cap stocks might have lower trading volumes.
- Economic sensitivity: Small firms are more vulnerable to economic downturns.
As an investor, it makes sense to invest only a part of your portfolio in small-cap funds after ensuring it aligns with your risk-taking capacity and investment objectives.
- Review during market highs
Sudden rallies can inflate your small-cap allocation. It’s wise to review and rebalance to prevent excessive exposure and keep your investments aligned with your original asset mix.
Taxation of small-cap funds
These mutual funds are taxed as equity funds in India:
- Short-term capital gains (held for less than one year) are taxed at 20%.
- Long-term capital gains (held for more than 1 year) over ₹1.25 lakhs in a financial year are taxed at 12.5% without indexation.
Getting started
To start your small-cap fund investment journey:
- Review your risk appetite and financial goals.
- Select worthy fund houses with a good history.
- Pick consistently performing funds and seasoned management.
- Begin with SIPs for discipline and to avoid market timing risks.
Invest in small-cap funds today
Small-cap schemes can serve as an effective wealth-making tool for disciplined and patient investors. If you consistently invest through SIPs and maintain a long-term approach, you may be able to benefit from the high growth opportunity offered by small companies. While these investments inherently carry some risks, their historical trends portray they are capable of making significant money over the long run, turning retail investors into millionaires via persistence and intelligent planning.