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Should I invest in small-cap funds for the education of my two-year-old baby?

If you understand the dynamics of small-cap funds, then bond with these funds for higher returns, says Dhirendra Kumar

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I have started investing in small-cap funds for my two-year-old child's higher education. Is this the right thing to do?
- Harish

Maybe, maybe not. If this is your first investment and you have started out with a small-cap fund, then it may not be the right thing to do. This is because, for a first-time investor, the erratic behaviour of small-cap funds could be scary.

However, if you understand what small-cap funds are, you can maintain your discipline in the worst of times and won't run away. Then, by all means, carry on with your investments in selected small-cap funds. They can potentially deliver you more returns.

Having said that, there is a catch when investing in small-cap funds. While investing in an aggressive hybrid or a multi-cap fund, the allocation itself takes care of diversity in your portfolio. But this isn't the case with small-cap funds. I think when it comes to investing in a small-cap fund, one has to be a little more active. So, be prepared to take a call because a great small-cap fund for two-five years may not be the best small-cap fund for the next five years. With small-cap funds, there exists the phenomenon of the winner's curse. Small caps investing in smaller companies stocks do well when they're small in size. As a result of their strong performance, they get more money. Now, once that happens, it becomes difficult for these funds to replicate their earlier strategies. Further, the fund manager's ability to replicate the performance gets dampened.

So, in this sense, invest in small caps but make sure that you carry on through all the lean times. Further, be prepared to track your fund's performance record and change your fund accordingly every two-three years as the winner's curse is inevitable.