The decision regarding mutual fund category to invest in would primarily depend upon the investor’s risk tolerance and investment horizon.
Are you often confused on how and when to choose between large-cap, multi-cap, mid-cap and small-cap funds? A large range of mutual funds options are available in the market to help investors to achieve their allocations across mutual funds. However, the decision regarding mutual fund category to invest in would primarily depend upon the investor’s risk tolerance and investment horizon. For those looking to invest for long term, i.e. above 5 years, equity mutual funds would be the most suitable choice compared to debt funds.
Manish Kothari, Director & Head of Mutual Funds, Paisabazaar.com said that if you are a risk averse investor, you can consider investing either in multi-cap or large-cap equity funds, since these funds are potentially low on volatility. Large-cap funds primarily invest a larger proportion of their investment in companies that have a larger market capitalisation, and have therefore proven stability and consistency in their returns over a period of time. Whereas multi cap funds incorporate a mix of large-cap, mid-cap and small-cap stocks in its portfolio, by investing in equity shares of companies belonging to different market capitalisation. Large cap is relatively less risky than pure mid cap or small-cap funds,” he said.
In terms of portfolio construction, there are a few basic factors you need to consider. The important ones discussed here can help you get a clear picture while selecting funds among the various categories:
Let us take a look at 5 factors which help decide on mutual fund categories.
Pick a mutual fund based on risk profile
Risk profile is the ability and willingness to bear risk. A conservative investor must consider large-cap funds. They generate wealth, slowly and steadily over the long term. These are steady performers which pay regular dividends.
C.S.Sudheer, CEO and Founder of IndianMoney.com, told Moneycontrol that large-caps have performed very well over the last year, even as mid-caps and small-caps are going through a severe correction. A volatile market has forced investors to seek solace in large-cap funds.
“Mid-caps and small-caps are for investors with high risk tolerance. They outperform large-caps in a bull market but could crash in a bear market. Small-caps are for investors with high risk appetite, seeking very high returns,” he said
Look at expense ratio
Total Expense Ratio (TER) is the expenses involved in managing and operating the fund. Sudheer says mutual funds with lower expense ratio generally outperform those with higher expense ratio. “Large-caps have lower expense ratio vis-à-vis mid-caps and small-caps, as expenses are spread over a fund of very large size. Mid-caps and small-caps have a higher expense ratio as they meet expenses over a smaller asset base,” he added.
Invest based on time horizon
Time horizon is the time you can stay invested in a mutual fund. Invest in equity mutual funds for the long-term of at least 5-7 years. The past equity trends have shown that 10-year returns of small-caps are higher than large-cap funds over the same period. Small-caps are good performers even over a 5-year period. The trick of making money in any mutual fund is staying invested for the long-term. Invest in small-caps over large-caps and even mid-caps, if you have a time horizon of 10 years or more.
Small-caps and mid-caps are not suitable for everyone
Investing in small-caps is not just the volatility. Good research cuts down risk in small-caps, which is beyond the scope of first-timers. “It would be wise for first-timers to stick to large-caps. If you are not capable of ‘Do It Yourself’ investing, stay away from mid-caps and small-caps. They are not meant for everyone. A first-timer who invests in a small-cap and sees the portfolio erode by 15-20% would panic and exit the scheme, never reaching financial goals,” said Sudheer.
Look for diversification
Diversification is not investing in two mid-caps and two small-caps. Diversify across categories. First-timers could invest in one large-cap, mid-cap and small-cap. One fund category that stands out is multi-cap funds. They are equity diversified funds which invest in Companies of different market capitalization.
Sudheer said multi-cap funds have been exceptional performers over the past year. They don’t face restrictions vis-à-vis Company size. A large-cap has to invest only in large-cap Companies and a small-cap in small-cap companies. “Multi-cap funds have the opportunity of investing across markets. Invest in multi-caps if you are a moderate risk-taker looking for long-term wealth creation,” he said.Be Wise, Get Rich.