It tends to be a new adventure for a newcomer to be lost in the complex art of investing. In the beginning, I was completely absorbed by all the available investment channels and this condition was worsened by my lack of knowledge in this field. For example, I had $5000 in one of my bank accounts, but I never considered investment. It was hard for me to decide. However, this project could be the best on the financial markets and I would feel great earning more money by learning new ways of investing. It made me want to invest more!

If a story could let me offer a window into direct contact, let me take you back to the year 2018. It was not that long ago, although my life was completely different, I have managed to put my $5000 savings into mutual funds. It is important to note that mutual funds are an effective way to diversify. 

Understanding Mutual Funds: The Basics

A mutual fund allows people to come together to invest their assets as a bunch by putting them together as a unique singular resource investing them in stocks, bonds, and the rest. For instance, an investment group comprises mostly the other participants and you in the fund.

You can depend on the professional fund managers to manage your investments. They study market trends and carefully choose which stocks to buy and sell. This takes away the challenge of deciding which stock to buy or sell.

How Do Mutual Funds Work?

Let me give you a simple example. Imagine you and 999 other people each invest ₹1,000 in a mutual fund. The fund manager now has ₹10 lakhs to invest. They might invest:

Let me illustrate this important point with a simple example. Supplementing that, you and the other 999 people can together provide the fund manager with the sum of ₹10,00,000, out of which each has invested ₹1,000. The fund manager now has about 10 lakhs which is more than enough to invest. They might invest:

• 60% in strong companies like TCS or HDFC
• 30% in government bonds
• 10% in bank deposits

With this investment, you are considered a unit of the fund equivalent to the underwriting amount. The growth of the fund will lead to an increased unit value. 

Why Should You Consider Mutual Fund Investment?

Mutual fund investments have various benefits that make them a favourite among newbies:

• Professional Management

You benefit from trained fund managers who work hard to get ready for market analysis. They are the ones who make the investment decisions through an extensive investigation and a wide area of the market.

• Diversification Benefits

Never forget that you should avoid the common maxim, “Don’t put all your eggs in one basket.” Mutual funds convey your money into different investments. Consequently, if one investment does not do well, you are out of risk.

Types of Mutual Funds You Should Know

The concept of investing in different types of funds is a prerequisite for making informed decisions. Below is a detailed overview of them:

1. Equity Mutual Funds

These are the kinds of funds which are mostly invested in the stocks. They carry the possibility of high potential returns, but they are also related to higher risks. Zerodha is a very good place to begin with investing in the best-performing equity mutual funds that it offers to customers.

• Large Cap Funds

• They are investments in well-established companies
• Compared to the other common investment opportunities, the risk is lower in such mutual equity funds
• Less aggressive investors can benefit from it

• Mid Cap Funds

• You can trust the company when the company is in the midst of its growth.
• Growth is not only more but also faster.
• Risk is at a moderate level.

• Small Cap Mutual Funds

• This is an investment that can be made in the companies that are on the rise.
• The Highest growth rates can be reached by making this type of investment.
• Ups and downs are bigger in comparison to others.

2. Debt Mutual Funds

Steady returns can be found in a variety of funds in which fixed-income bonds and other debt instruments are the main investment. The risk tolerance of bond funds generally falls below that of the funds investing in growth stocks.

• Government Security Bond Funds
• Corporate Papers Funds
• Liquidity Fund

3. Hybrid Funds

These are a mix of both and fixed income assets inclusion.

• Balanced Funds (50% equity, 50% debt)
• Aggressive Hybrid Funds (65-80% equity)
• Conservative Hybrid Funds (75-90% debt)

Risk-Return Scale

Risk Level: 

• Debt Funds : Low [–●————-] High
• Hybrid Funds: Low [——-●——–] High
• Equity Funds: Low [———–●—-] High

Investment Amount Comparison

Fund Type	Minimum SIP	Minimum Lump	Lock-In Period
Large Cap	₹500	₹5000	None
Mid Cap	₹500	₹5000	None
Small Cap	₹500	₹5000	None
Equity Linked Savings Scheme (ELSS)	₹500	₹500	3 Years
Debt	₹500	₹5000	None
Liquid	₹500	₹500	None

How to Choose the Best Mutual Funds

Selecting the best mutual funds involves several factors:

• Your Investment Goals
• Risk Tolerance
• Investment Timeline
• Fund Performance History
• Expense Ratios

Paytm Money provides excellent tools for comparing these factors.

The Power of Small Cap Mutual Funds

Understanding Small Cap Mutual Funds

Small-cap mutual funds emphasize the stocks which have less than ₹5,000 crore of market capitalization. Imagine this: It is as if large-cap corporations are mighty trees while small-cap firms are newly planted trees. In the same way, as the sapling has more space to grow than the old oak, small-cap businesses generally have a larger growth opportunity.

Why Consider Small Cap Funds?

1. Growth Potential Explained

In almost all instances, smaller IT companies develop custom software for electric vehicle manufacturers. A car can travel a longer distance without needing to be recharged when it uses such new technology. Once the company absorbs profits from the ever-increasing EV market, the growth will be symbolic. Some of the industrial leaders we know nowadays like Page Industries were once small-cap companies that have managed to become big players in their respective industries.

2. Market Dynamics

Usually, institutional investors show no interest in these companies owing to their small size. But, this condition gives an excellent opportunity to individual traders. When I first invested in small-cap funds through Alice Blue, I noticed many portfolio companies were unknown names that later became household brands.

Investment Strategies for Small Cap Funds

1. Systematic Investment Plan (SIP) Approach

Oftentimes, attempting to avert risk to gain profits can increase your rates, but this does not mean one needs to invest a lot of money. Why not use the following sample: If you consistently invest ₹5,000 each month in a small-cap fund, then you distribute your risk over the possible market conditions. I witnessed months when I was offered products at ₹ 40 and when prices reached ₹ 25, yet my purchase cost averaged out effectively

2. Portfolio Allocation Strategy

You should consider your investment portfolio as a daily diet. No matter if it’s sweet or sour, you wouldn’t scrap the idea of the main dish and would eat just desserts. Similarly, you shouldn’t concentrate too much on small-cap funds. This is an example of the practical allocation strategy based on an investor’s risk appetite:

Conservative Investor:

• Maximum 10% in small-cap funds
• 50% in large-cap funds
• 40% in debt funds

Aggressive Investor:

• Up to 25% in small-cap funds
• 45% in large-cap funds
• 30% in mid-cap funds

Risk Management in Small Cap Investing

1. Market Risks Understanding

Higher risk is one of the trade-offs of great reward when investing in small-cap stocks that only small companies face. A case of the market crisis of 2020 makes a specific example: whereas large-cap stocks dropped about 25%, many small-cap stocks fell 40-50%. This phenomenon is operational in two aspects of the market:

Trading Volume Impact: A low trading volume will be affected less by a large investor selling 10 lakh shares. Only 1-2% varies the respective index in large-cap stocks, while it can fall to 10-15% on small-cap stocks due to the low volume of trades.

Economic Sensitivity: When dealing with the COVID-19 pandemic outbreak, many small businesses were at their lowest working capital. On the other hand, big companies were in a better position as they had more financial reserves to survive the tough times.

2. Business Risk Analysis

Small companies face certain risks that are not present in larger companies. To illustrate, a small-cap pharmaceutical company whose main product was responsible for 70% of its revenue once was tracked by me through Zerodha. When a bigger competitor launched a product similar to theirs, the stock price of the company dropped by 40%. This shows that a small business could be having concentration risk.

3. Risk Mitigation Techniques

So, here is a pragmatic method for the small-cap fund’s risk management:

Invest Horizon Planning:

• Year 1-3: Investment to be done gradually through SIPs
• Year 3-5: Handle it by passing through the troughs and peaks of the cycle
• Year 5+: Deal with the situation according to your objectives and readjust your investment.

Diversification Strategy:

• Invest in several small-cap companies
• Each fund should hold shares in other sectors
• Examine the sector concentration at the end of each quarter

Small Cap Fund Selection Process

1. Fund Manager Evaluation

Consider fund managers who are good at one or two things. For example, in my research on Paytm Money, a small-cap funds manager has been skillfully handling a vast array of stocks, even through the tough times from 2008 onwards. They were able to demonstrate their professional behaviour by being calm during the 2020 tumble.

2. Portfolio Analysis

Analyze the details of the fund’s different investments accurately.

Sector Global Distribution:

• IT & Technology: 20-25%
• Manufacture: 15-20%
• Health: 15-20%
• Consumer: 15-20%
• Others: 20-25%

Size of the position:

• An investor should not let more than 40% of a portfolio be held by the top 10 holdings
• Individual stock exposure is typically less than 5%
• Cash holdings are kept between 5-10%

FAQs

What is the minimum investment to start investing in mutual funds?

You can commence your investment with as low as ₹500 using SIP.

Are mutual funds safe for beginners?

Yes, they are, especially on a regulated platform and if you start with either a balanced or large-cap fund.

How much time should I allocate for the investment?

Depends on your goals, but usually these are the limits:

• Equity funds: 5+ years

• Debt funds: 1-3 years

• Hybrid funds: 3-5 years

Is it possible to lose money in mutual funds?

Yes, but diversification can help to minimize this risk. Owing to such a situation, total loss is virtually non-existent.

How can I follow my investments?

Restricting the choices to the fund house or an app such as Paytm Money among others would be the right option for tracking. 

Conclusion

Mutual funds are the best way of investing, they adjust to the needs of both beginners and people who have been through this before. Start with the smallest amount of money you can afford, be consistent and make sure you are making investments according to your goals. Do not forget to remember that successful investing is more of a marathon instead of a sprint.

For those who are interested in more peculiar information to analyze investments, look for the article “Introduction to Fundamental Analysis: The Key to Long-Term Investing“.