Which market cap suits you best; Large cap, mid cap or small cap?

Which market cap suits you best; Large cap, mid cap or small cap?

Akriti, a young lawyer, sees many people around her investing in equity mutual funds by way of SIP or lump sum. Some directly invest in stocks and others in mutual fund schemes, as recommended by their advisers, while only a few do their own research. She realises that equity shares or mutual funds are typically categorised as large cap, mid cap or small cap. In order to decide which one she should invest in, she would like to understand the basis of such categorisation, how risky the investment is likely to be and what sort of return she can expect? She is looking at equity investments to help her with some goals – like retirement, buying a car and funding her marriage.

Stocks in each category (large, mid, and small) have identifiable risk and return characteristics. These categories can be considered a proxy for their size or what is technically known as ‘market cap.’ Large-cap companies have a well-established business and are generally the ‘big fish’ in the industry that they operate in. The profitability and sales growth of these companies are usually constant. So, the performance of the large-cap companies is typically stable compared with other smaller companies.

Small-cap companies are the other end of the extreme. They are in the early stage of business and have a lot of scope for expansion and growth. Hence, they have the potential of earning very high profits compared with large caps. But they may not be financially strong enough to be able to withstand a bad economic situation. This may lead to a steep fall in their profitability and hence, their share price. Mid-cap companies share some of the growth characteristics of smallcap companies, but they carry less risk because they are slightly larger.

For Akriti, understanding the pros and cons of the various market cap funds is a good first step to determining which funds best suit your portfolio, your investment horizon, and your investment style. If she is a conservative investor and is unwilling to take on much risk, then large caps are advisable. She must only consider investing in mid and small caps if she is willing to take high risk to earn higher returns and has a longer investment horizon, so as not to be tormented with the short-term volatility. She must realise that along with a possibility of high returns, comes higher risk. She might be better off investing in such stocks in combination with large caps for very long-term goals, such as retirement.
Content on this page is courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.

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Author: Shirley