Mutual funds make for an appealing investment option because they offer diversification, professional management, and a relatively low barrier to entry, making them an excellent option for those looking to grow their wealth over the long term. Are you with us so far?
Because today, we’ll be talking about an important aspect of mutual fund investing in India (um, or anywhere really!) – market capitalization.
What is market capitalization?
Market capitalization, often referred to as “market cap,” is a crucial factor that can significantly impact your mutual fund investments. It is a measure of a company’s total value in the stock market and is calculated by multiplying the company’s total outstanding shares by the current market price per share.
To put it simply, the market capitalization of a company represents the market’s consensus on the company’s worth. So, this becomes an important aspect of investing that any young investor should know about in order to make sound investment decisions when trading in mutual funds. Companies with higher market capitalizations are generally considered to be more stable and established, while those with lower market capitalizations are often seen as riskier and more volatile. Make note – the market capitalization of a company should be a key factor to consider when planning your investment strategy!
Fund Categories Based on Market Capitalization
Mutual funds are typically categorized into three primary categories based on the market cap of the stocks they invest in –
- Small-Cap Funds – Small-cap funds primarily invest in stocks of small-cap companies with market capitalizations typically less than a billion dollars. Small-cap funds are usually known for their high growth potential but come with higher risk. These funds are likely to be better suited for experienced, if not aggressive investors, who are willing to take on more significant risks for potentially higher returns.
- Mid-Cap Funds – These funds invest in stocks of mid-sized companies with market capitalizations ranging from a few hundred million to a few billion dollars. Mid-cap funds are perceived as having moderate growth potential and moderate risk. These funds are suitable for investors who are looking for a balance between growth and risk, but have a relatively higher risk tolerance than newbie investors!
- Large-Cap Funds – These funds invest primarily in stocks of large-cap companies. Large-cap companies are well-established firms with a market capitalization of several billion dollars. They are known for their stability and relatively lower growth potential. These funds are considered less risky and are often suitable for conservative investors, or even first-time investors like you!
Market Capitalization in the Indian Economy
It is important to remember the importance of understanding the risk-reward parameters before investing in any of these mutual fund categories, even after you have researched the market capitalization for each.
Impact of Market Capitalization in India on Mutual Funds
We’ve already said that market capitalization has an impact on your investments. Here are some elements of mutual fund investing that are directly related to a company’s market capitalization –
- Risk and Return – As mentioned earlier, the size of the companies in a mutual fund’s portfolio directly affects the risk-return profile of the fund (and by extension of your investments!). Large-cap funds are less risky but offer lower growth potential, while small-cap funds are riskier but can provide higher returns. Mid-cap funds strike a balance between risk and return. So, you have a choice to make, and your choice should depend on your individual risk tolerance and personal investment objectives.
- Diversification – Market capitalization also affects the level of diversification in a mutual fund. Large-cap funds tend to be less diversified, as they focus on a smaller number of well-established companies. In contrast, small-cap funds often invest in a more extensive range of companies, offering greater diversification. As you already know – diversification helps reduce the risk associated with individual stocks. So you have to decide how you want to diversify to most accurately mitigate your investment risk.
- Market Cycles – Different market capitalization categories may perform better in different market cycles. Large-cap stocks are generally more stable and can provide a safe haven during market downturns, whereas small-cap stocks can experience substantial growth during bull markets but may be more volatile during bear markets (here’s some more information on the bull and bear!). Mid-cap stocks provide a balance and can adapt to various market conditions. It is entirely up to you to consider market capitalizations and make investment decisions when market conditions are favorable for various categories of mutual funds.
- Investment Horizon – Your investment horizon plays a significant role in determining the suitable market capitalization category for you. If you have a long investment horizon and are investing to achieve major milestones in life, you may consider a mix of large-cap, mid-cap, and small-cap funds to balance growth and risk over time. On the other hand, short-term investors may focus on large-cap funds for stability. Your investment horizon, coupled with your risk tolerance will influence your total gains – so choose wisely!
- Performance Comparison – Market capitalization provides a benchmark when it comes to comparing the performance of various mutual funds. Large-cap funds are typically compared to the Nifty 50 or BSE Sensex, mid-cap funds to the Nifty Midcap 100, and small-cap funds to the Nifty Smallcap 100. This information ultimately helps you gauge how well a fund has performed relative to its peers in the same market cap category. So, if you notice that your selected fund is regularly underperforming its benchmarks, you can take action and reallocate your investments to align with your goals.
As a young investor in India, you have a long investment horizon ahead of you. Use this to your advantage by making informed choices that align with your financial aspirations. Market capitalization is just one tool in your investment toolbox (although it is arguably one of the most important ones!), and mastering its use will help you on your journey to financial success.
- What is the meaning of market capitalization?
Market capitalization, often referred to as “market cap,” is a measure of a company’s total value in the stock market.
- How to calculate market capitalization?
Market capitalization is calculated by multiplying the company’s total outstanding shares by the current market price per share.
- What is the formula for market capitalization?
The formula for market capitalization is – The company’s total outstanding shares x The current market price per share.
- How does market capitalization influence mutual fund investments?
Market capitalization has an impact on the risk-reward, diversification, investment horizon, and performance comparison of mutual fund investments. It is an important benchmark for you to keep track of.