Are you a busy parent of a newborn baby? You must have experienced the exhaustion from the constant attention and care that it needs for the next few years. As a parent, you are bound to be a constant provider in expectation of a brighter future for your child and yourself. For a new investor, a small-cap fund acts similarly. It craves constant attention and monitoring, and in anticipation of high returns, you are compelled to consider it. As 90% of the funds are invested in startups or new companies with market caps below Rs. 5000 crores and ranked from 251st onwards, they are extremely volatile and react strongly to any market downturns. Despite the risk, some investors might choose small caps for retirement planning, considering higher returns in a long-term perspective. But is time the only factor while you save for your future?   

Understanding Small Cap Funds

The mutual funds that hold 90% in stocks of companies that have a market capitalisation of less than Rs 5000 crore and are ranked 251st onwards as per capitalisation are called small cap funds. A start-up or a company that is under development and has negligible market presence usually falls under this sector. Though they have high growth and return potential, they are equally risky as they do not have the financial and resource strength to weather any kind of downturn in the economy or market. A slight change in the market dynamics impacts these funds significantly. Considering historical performances, it has been found that small caps have generated maximum returns of 38.01% p.a on average in the past 5 years.  

Pros of Investing in Small Cap Funds for Retirement

As is clear from the definition, small caps invest in new entrants and start-ups. These have a high potential for exponential growth as they try aggressively to capture the market and establish their existence. If supported by a strong business model and market-appropriate strategies, they are often successful in becoming a market leader in their sector. Due to this high growth rate, the returns are usually higher than mid or large-cap, though their market capitalisation is nowhere near them. In anticipation of this high return post 5-10 years, small caps seem to be extremely lucrative for wealth accumulation for your retirement days. Added to this, if you follow the Systematic Investment Plan, where your risks are further levelled down due to rupee cost averaging, small caps seem to be perfect instruments to build a corpus to enjoy in your post-career golden days.   

Cons of Small Cap Funds for Retirement

When a one-year-old infant tries to walk, doesn’t it fall more often? God forbid if it is an uneven terrain. Even a slight rough ground makes it a daunting task for a toddler to walk. The small caps behave the same way in case of market ups and downs. During a bullish market, the returns will be sky-high, and if the market crashes, these funds tend to perform so low that recovery takes a few more market cycles. The losses are as significant as the returns it generates. In case of an emergency, it becomes impossible to redeem funds in the short term. Also, if you want to reallocate due to the underperformance of a small cap, you will need to wait for withdrawal, as the risk of losing capital is higher if you redeem before the time. The liquidity in any small-cap fund is lower as it is extremely sensitive to market corrections and takes time to bounce back. So, withdrawal will mean more losses in your portfolio; at the same time, staying invested might not guarantee an expected level of returns.            

How to Use Small Cap Funds in Retirement Planning?

Retirement planning requires various factors like inflation rates, increased life expectancy, and escalating medical expenses to be considered before you decide on the retirement corpus. If you are new to the stock market, the beginning of your investment journey might be overwhelming. But suppose you break up your allocation strategy as per your career phases. In that case, it might seem plausible to have an acceptable corpus without worrying about the high risk and instability of the market. 

If you are in an early phase of your career within the age range of 30 to 40 years, you might consider a higher allocation of at least 20-30 % of your portfolio to small-cap funds for long-term wealth gain. It is even prudent to invest via the Systematic Investment Plan to lower your risk and average out your returns.  

In your 50s, you would prefer to take a little less risk and shift 10 to 15% to a balanced fund for some stability yet better returns. The rest, 10-15% in small caps, should be kept with a longer horizon for the portfolio’s incremental return for the next 10 years. 

When you are nearing your retirement age of 60 to 65 years, it is time to enjoy more sustainable and stable returns despite any market changes. You should be able to withdraw funds in an emergency or for any medical expenses without incurring losses. Hence, the risk should be completely minimised, and the 10-15% should be reallocated to balanced advantage funds or large cap funds, which are least impacted by volatility.

Top Small-cap Mutual Funds Sorted by Historical Returns

The top 5 small-cap funds clearly show improvement with time and prove that high returns are generated if given adequate time to counter volatility.  

Conclusion: Are Small Cap Funds Right for Retirement?

To answer this question, you first need to assess your investment horizon and your ability to absorb losses. If you are an aggressive investor with a high-risk appetite and are planning an early retirement, it may be a good idea to go all out for small-cap funds. But if you are in your 50s and are nearing your retirement, when you might need to withdraw funds within a short span, go for a time-tested, stable fund that has a balance of debt and equity. Debt will provide stability and equity, the required returns. 

Are you a busy parent of a newborn baby? You must have experienced the exhaustion from the constant attention and care that it needs for the next few years. As a parent, you are bound to be a constant provider in expectation of a brighter future for your child and yourself. For a new investor, a small-cap fund acts similarly. It craves constant attention and monitoring, and in anticipation of high returns, you are compelled to consider it. As 90% of the funds are invested in startups or new companies with market caps below Rs. 5000 crores and ranked from 251st onwards, they are extremely volatile and react strongly to any market downturns. Despite the risk, some investors might choose small caps for retirement planning, considering higher returns in a long-term perspective. But is time the only factor while you save for your future?   

Understanding Small Cap Funds

The mutual funds that hold 90% in stocks of companies that have a market capitalisation of less than Rs 5000 crore and are ranked 251st onwards as per capitalisation are called small cap funds. A start-up or a company that is under development and has negligible market presence usually falls under this sector. Though they have high growth and return potential, they are equally risky as they do not have the financial and resource strength to weather any kind of downturn in the economy or market. A slight change in the market dynamics impacts these funds significantly. Considering historical performances, it has been found that small caps have generated maximum returns of 38.01% p.a on average in the past 5 years.  

Pros of Investing in Small Cap Funds for Retirement

As is clear from the definition, small caps invest in new entrants and start-ups. These have a high potential for exponential growth as they try aggressively to capture the market and establish their existence. If supported by a strong business model and market-appropriate strategies, they are often successful in becoming a market leader in their sector. Due to this high growth rate, the returns are usually higher than mid or large-cap, though their market capitalisation is nowhere near them. In anticipation of this high return post 5-10 years, small caps seem to be extremely lucrative for wealth accumulation for your retirement days. Added to this, if you follow the Systematic Investment Plan, where your risks are further levelled down due to rupee cost averaging, small caps seem to be perfect instruments to build a corpus to enjoy in your post-career golden days.   

Cons of Small Cap Funds for Retirement

When a one-year-old infant tries to walk, doesn’t it fall more often? God forbid if it is an uneven terrain. Even a slight rough ground makes it a daunting task for a toddler to walk. The small caps behave the same way in case of market ups and downs. During a bullish market, the returns will be sky-high, and if the market crashes, these funds tend to perform so low that recovery takes a few more market cycles. The losses are as significant as the returns it generates. In case of an emergency, it becomes impossible to redeem funds in the short term. Also, if you want to reallocate due to the underperformance of a small cap, you will need to wait for withdrawal, as the risk of losing capital is higher if you redeem before the time. The liquidity in any small-cap fund is lower as it is extremely sensitive to market corrections and takes time to bounce back. So, withdrawal will mean more losses in your portfolio; at the same time, staying invested might not guarantee an expected level of returns.            

How to Use Small Cap Funds in Retirement Planning?

Retirement planning requires various factors like inflation rates, increased life expectancy, and escalating medical expenses to be considered before you decide on the retirement corpus. If you are new to the stock market, the beginning of your investment journey might be overwhelming. But suppose you break up your allocation strategy as per your career phases. In that case, it might seem plausible to have an acceptable corpus without worrying about the high risk and instability of the market. 

If you are in an early phase of your career within the age range of 30 to 40 years, you might consider a higher allocation of at least 20-30 % of your portfolio to small-cap funds for long-term wealth gain. It is even prudent to invest via the Systematic Investment Plan to lower your risk and average out your returns.  

In your 50s, you would prefer to take a little less risk and shift 10 to 15% to a balanced fund for some stability yet better returns. The rest, 10-15% in small caps, should be kept with a longer horizon for the portfolio’s incremental return for the next 10 years. 

When you are nearing your retirement age of 60 to 65 years, it is time to enjoy more sustainable and stable returns despite any market changes. You should be able to withdraw funds in an emergency or for any medical expenses without incurring losses. Hence, the risk should be completely minimised, and the 10-15% should be reallocated to balanced advantage funds or large cap funds, which are least impacted by volatility.

Top Small-cap Mutual Funds Sorted by Historical Returns

The top 5 small-cap funds clearly show improvement with time and prove that high returns are generated if given adequate time to counter volatility.  

Conclusion: Are Small Cap Funds Right for Retirement?

To answer this question, you first need to assess your investment horizon and your ability to absorb losses. If you are an aggressive investor with a high-risk appetite and are planning an early retirement, it may be a good idea to go all out for small-cap funds. But if you are in your 50s and are nearing your retirement, when you might need to withdraw funds within a short span, go for a time-tested, stable fund that has a balance of debt and equity. Debt will provide stability and equity, the required returns.