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Should I invest in high risk/return small cap MFs with 15 lacs for 3-5 years?

Ramalingam Kalirajan |7290 Answers |Ask -Follow

Mutual Funds, Financial Planning Expert - Answered on Aug 29, 2024

Ramalingam Kalirajan has over 23 years of experience in mutual funds and financial planning.
He has an MBA in finance from the University of Madras and is a certified financial planner.
He is the director and chief financial planner at Holistic Investment, a Chennai-based firm that offers financial planning and wealth management advice.... more

Asked by Anonymous - Aug 22, 2024Hindi

Hi Dev, I have around 15 lacs to invest in MF. Already have invested 8 lacs already in Nifty 50 index, PSU Equity and Bharat 22 FoF. I want to invest in high risk/returns MFs like small cap MFs but considering market is already at all time high, expecting corrections and small caps MFs already peaked is it safe to invest in these considering 3-5 yr timeline (lumpsum or SIP). If not then in what other MFs can be invested. Thanks in advance

Ans: Congratulations on accumulating Rs. 15 lakhs for investment in mutual funds. It shows your commitment to growing your wealth strategically. You're already invested in Nifty 50 index, PSU Equity, and Bharat 22 FoF, which indicates a strong foundation in diversified portfolios. Now, you're contemplating investing in high-risk, high-return mutual funds, particularly small-cap funds, considering the current market scenario. This is indeed a prudent moment to evaluate your options carefully.

Understanding Market Conditions

Before diving into small-cap funds, let's assess the current market conditions. The market, as you mentioned, is at an all-time high. Small-cap funds have shown significant growth, which can often precede a market correction. Small-cap funds are known for their volatility, which can result in sharp downturns when markets correct.

Given your investment horizon of 3-5 years, it’s important to consider whether the potential for high returns justifies the risks. Historically, small-cap funds perform exceptionally well during market rallies but can also suffer steep losses during downturns. Since you expect a market correction, timing your entry into these funds becomes crucial.

Assessing the Small-Cap Fund Option

Small-cap funds are attractive due to their potential for high returns. They invest in smaller companies that have significant growth potential. However, these companies are also more susceptible to market fluctuations and economic downturns. Here’s why investing in small-cap funds now requires careful consideration:

High Valuations: With small-cap stocks trading at high valuations, the risk of a downturn increases. If the market corrects, these funds might experience significant losses.

Short-Term Volatility: In the short to medium term, small-cap funds are highly volatile. A 3-5 year horizon might be tight for recovering from potential losses during a market correction.

Lump Sum vs SIP: Given the potential for market correction, investing in small-cap funds via SIP (Systematic Investment Plan) rather than lump sum can be a better strategy. SIPs help average out the cost of investment, reducing the impact of volatility.

Exploring Other High-Risk, High-Return Mutual Funds

If small-cap funds seem too risky given the market conditions, there are other mutual fund categories that can offer high returns, albeit with varying levels of risk. Here are some alternatives:

Mid-Cap Funds: These funds invest in companies with medium market capitalisation. They offer a balance between the high growth potential of small-caps and the stability of large-caps. Mid-cap funds can provide substantial returns, especially in a growing economy, and might be less volatile compared to small-caps.

Sectoral/Thematic Funds: These funds invest in specific sectors or themes such as technology, healthcare, or energy. While they are risky, they can provide high returns if the particular sector performs well. However, these funds require a deep understanding of the sector and come with the risk of concentration.

Flexi-Cap Funds: These funds have the flexibility to invest across market capitalisations, including large-cap, mid-cap, and small-cap stocks. They offer diversified exposure and can help mitigate risks associated with market timing, as fund managers adjust the portfolio based on market conditions.

Multi-Cap Funds: Similar to flexi-cap funds, multi-cap funds invest across market capitalisations but follow a set allocation between large, mid, and small-cap stocks. They offer a good mix of stability and growth potential, reducing reliance on a single market cap category.

Actively Managed Funds vs. Index Funds

You’ve already invested in an index fund, which is a passive investment strategy. While index funds are low-cost and offer returns that mirror the market, they lack the flexibility to outperform the market. In contrast, actively managed funds, especially in the mid and small-cap space, provide fund managers the discretion to pick stocks that can potentially outperform the market.

Index Fund Limitations: Index funds are constrained by the index they track, which means they cannot make strategic decisions based on market conditions. During a market correction, index funds might suffer as much as the market.

Advantages of Actively Managed Funds: Actively managed funds can adapt to market changes, with fund managers making informed decisions to safeguard the portfolio. Over the long term, good fund managers can significantly outperform the market, especially in the mid and small-cap segments.

Direct Funds vs. Regular Funds

Investing directly in mutual funds might seem attractive due to lower expense ratios, but it often lacks the guidance and expertise that comes with investing through a certified financial planner (CFP). Here's why considering regular funds through a CFP might be more beneficial:

Guidance and Expertise: A CFP provides professional advice tailored to your financial goals, risk tolerance, and market conditions. This personalized guidance can be crucial, especially in volatile markets.

Holistic Financial Planning: A CFP looks at your entire financial picture, including tax planning, retirement, and other financial goals, ensuring that your mutual fund investments align with your overall financial strategy.

Behavioral Support: During market downturns, investors often panic and make hasty decisions. A CFP helps you stay the course, providing support and advice that can prevent costly mistakes.

SIP or Lump Sum Investment?

Given the current market conditions, investing in mutual funds through SIPs is generally safer than a lump sum investment. Here’s why:

Rupee Cost Averaging: SIPs help in averaging the purchase cost of your mutual fund units. This reduces the impact of market volatility, especially when markets are at all-time highs.

Disciplined Investing: SIPs instill a habit of regular investing, which is key to long-term wealth creation. They also reduce the emotional stress of trying to time the market.

Flexibility: SIPs offer the flexibility to adjust your investment amount based on your financial situation. You can also stop or pause SIPs if needed.

However, if you believe the market might correct soon and you’re prepared to handle short-term volatility, investing a portion as a lump sum during a market dip could lead to higher returns. Combining both strategies—investing a portion lump sum now and the rest through SIPs—might be a balanced approach.

Final Insights

Investing Rs. 15 lakhs in mutual funds is a significant financial decision. With the market at an all-time high, it’s wise to approach high-risk, high-return options like small-cap funds with caution. Here’s a summary of your potential strategy:

Diversify Beyond Small-Caps: Consider mid-cap, sectoral/thematic, flexi-cap, or multi-cap funds for a more balanced risk-return profile.

Prefer SIPs Over Lump Sum: SIPs offer a safer entry into the market, helping to manage volatility and reduce risk.

Leverage Active Fund Management: Actively managed funds can outperform in both rising and falling markets, making them a better choice over passive index funds.

Consult a CFP: Investing through a certified financial planner provides the expertise, guidance, and behavioral support needed to navigate volatile markets.

By diversifying your investments and choosing the right mix of funds, you can achieve your financial goals while managing risks effectively. Investing in mutual funds is not just about selecting the right fund but also about aligning your investments with your financial objectives and risk tolerance.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

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