How much should I allocate to Small Cap Mutual Funds if I need money after 25 years?

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: October 23, 2022 at 6:00 am

In this article, we discuss a set of questions sent by a reader about a 25-year investment duration. Among these, he wishes to know how much should be allocated to small cap mutual funds. We address them in the order received.

For a 25-year retirement goal, what will be your allocation percentage towards equity, gold and fixed income instruments for the first 15 years??? Do you consider cryptocurrencies as an asset class?

The simplest choice is equity (50% to 60%) and the rest in fixed income. This asset allocation can be varied in many ways. You can leave it as is for the first 15 years and then continuously taper down as the freefincal robo advisory template recommends. See, for example:

Regarding the allocation to gold, see the response below.

Cryptocurrencies are just that, currencies. We do not invest in currencies. We trade in them. A currency is the measure of an asset class. For example, “what is the price of gold per troy ounce in USD or INR?” In our opinion, it is not an asset class in itself. Of course, from the viewpoint of a trader, it is just another commodity like crude oil, silver, or wheat.

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The trouble with trading is that it would require a considerable expenditure in time and huge amounts of capital to make a difference. In our opinion, trading wastes time and money and can be safely avoided. Also, see:

For a 25-year retirement goal, what percentage of your equity portfolio will you allocate towards small cap mutual funds? In this small cap mutual fund portfolio, will you be allocating 100% to a passive index fund?

Small cap funds can be quite frustrating to hold. They lose almost all the gains from a bull run in the next bear run. So our recommendation is to avoid them altogether. See:

If FOMO (fear of missing out) is too much to tackle, then we recommend buying and selling actively managed small cap funds tactically. That is, use a momentum-based approach to buy when they move up and sell when they start to fall. It is imperfect and can fail but may be less frustrating than systematic small cap fund investing. See:

You also look at market trends like investing when small cap funds open for inflows and start redeeming when they close. We reiterate that such gymnastics are typically unproductive and are eminently unnecessary.

Small cap passive funds are expensive and notoriously difficult to follow the index (large tracking errors) due to large impact costs (poor market depth). They are best avoided. See: Not all index funds are the same! Beyond the top 100 stocks tracking errors are huge!

What percentage of your portfolio will be allocated to gold mutual funds for a 25-year-long investment goal?

Gold is as volatile as gold but not as rewarding in the long run. Gold does not always offer a reward commensurate with its risk. See Gold vs Equity (Sensex) 40-year return and risk comparison. We, therefore, recommend avoiding it. For some data, see: Can I add 10-20% gold to my 15-year investment portfolio?

Considering the ease of investing and safety, isn’t it better to allocate your fixed income portfolio to fixed deposits rather than investing in debt mutual funds for a long term goal?

That would be a terrible idea. Over time, your income will grow, and the tax you pay on the FD interest will increase and create a huge dent in your wealth. For long-term goals, a combination of tax-free fixed income like EPF or PPF combined with debt funds is the smart choice. There are ways to choose debt funds with reasonable and acceptable risks over the long term. See: