I invested Rs 3 lakh in small-cap funds last year. Big mistake?

A Telegram group message caught my eye during lunch: Small caps are giving killer returns! It was September 2024 and the numbers were indeed eye-popping.

A stellar 37 per cent returns in two years. Investor interest surged, and money was pouring in at record levels—Rs 3,071 crore in September 2024 alone.

Everyone wanted a piece of the action. A colleague boasted about his 30 per cent gains in just a few months. A friend in that Telegram group declared, "This is the best time to invest in small caps!" The FOMO was real.

I couldn't ignore it anymore. So, I took the plunge and invested Rs 3 lakh in small-cap mutual funds.

The reality check

Fast forward to February 2025, and that plunge has proved costly.

The BSE Smallcap Index has plunged nearly 14 per cent from its peak. My portfolio, which had briefly shown a modest gain in December, is now flashing red.

The same people who were hyping up small caps are now conspicuously silent—no more "best time to invest" slogans or confident predictions. The Telegram group that once buzzed with screenshots of gains is now quiet.

Just one question keeps me up at night: Did I make a huge mistake?

The lessons

Before addressing that, let me share what this rollercoaster is teaching me:

• A stormy ride, at least in the short term. Like a small boat in stormy seas, small-cap stocks can rise dramatically and fall just as hard in the short term. In the 2020 market crash, the small-cap index fell 43 per cent in just two months. But then it rallied 136 per cent over the next year. That's the kind of volatility we're talking about.
  
• Time isn't just important, it's everything. Look at Nippon India Small Cap Fund. Investors who stayed put through the 2018-20 crash (a 24 per cent fall from peak) saw their investments double by the end of 2021. Those who panicked and sold never recovered their losses.
  
• SIPs beat lumpsums. If I had split my Rs 3 lakh into monthly SIPs, I would have caught different price points instead of investing everything at the peak. SIPs work on rupee-cost averaging, meaning you buy more units when prices are low and fewer when they are high—automatically smoothing out volatility.
  
• Liquidity is a real challenge. During market corrections, small-cap stocks may face liquidity issues, making it difficult to exit positions without impacting the stock price. Unlike large-caps, which have deep markets, small-caps trade in lower volumes. This means when large investors sell, prices can nosedive quickly.
  
• Diversification is key. Relying solely on small caps is a recipe for stress. A more balanced allocation ensures stability while still capturing growth opportunities.

What now?

I won't lie; seeing my portfolio in the red stings. So, was it a mistake to invest in small-cap funds?

Yes, it was a mistake to invest a lumpsum at a peak purely based on FOMO. But it wasn't a mistake to invest in small-cap funds themselves.

Being under 30, time is on my side. Selling now would mean making my losses permanent. After all, small-cap funds have historically rewarded patient investors over the long term, delivering 21 per cent returns over 10-year periods.

I have made two changes, though. I've sworn off making lumpsum investments based on recent performance. And I've made portfolio rebalancing my ally.

A balanced allocation is crucial—allocating 50-70 per cent in large-cap funds for stability, 20-30 per cent in mid-cap funds for moderate growth and 10-20 per cent in small-cap funds for high-risk, high-reward exposure. When small caps surge, I'll trim some exposure and shift gains to more stable, large-cap funds. When they dip, I'll buy more to maintain the desired allocation.

That way, I'll not get caught napping. I hope you won't as well.

Also read: My junior colleague is richer than my manager. Here's how.

This article was originally published on February 06, 2025.