Will my gains reduce if I invest more in my small cap mutual fund?

A reader asks, “I initially invested 1.5 lakh rupees in a Smallcap mutual fund category two years ago and haven’t added any more funds since. I’m contemplating whether to resume investing in my existing fund or consider a new smallcap fund”.

“I’m interested in understanding the advantages and disadvantages of both options. It’s worth noting that my existing fund has performed exceptionally well, providing me with over a 100% absolute return. If I decide to invest more in this fund, will it potentially impact my gains due to averaging out?”

Investing for the long term typically takes 15 -30 years. Over this period, we must make repeated investments, sporadically, systematically or tactically. Some will be done in bull markets, bear markets, etc.

So, at the portfolio level, whether you invest in one fund or choose a new one, each time you have some cash to spare, there will always be some kind of “averaging” that cannot be avoided.

You can’t feel bad that your returns have gone down because you topped up the one lucky investment you made! This is why I keep saying returns (annualised or absolute) do not matter! All that matters is whether you have enough cash to fund your future.

So you go to stop fixating on that “100% absolute return” and move on. There are a couple of caveats, though.

You don’t have to worry about your next investment in a small cap fund to decrease your past returns. Even if you did not invest any more, those expectations returns would come crashing down sooner or later. That is how the small cap segment is. And that is why we strongly recommend avoiding it.

You should also consider the timing of your proposed investment. Is it motivated by the recent uptick in small cap stocks? At the time of writing, that could well be over! Naturally, we can’t predict how the market will move, but there has been a visible disruption of momentum over the last ten days, and who knows what that could lead? Are you ready to have a different experience with your second investment in a small cap fund?

Our general recommendations:

• Avoid all small cap stocks and mutual funds.
• If you “must have” small cap exposure, choose a flexicap fund (not a multicap fund)
• If you cannot stay from small cap funds, use our monthly mutual fund screener and find out how many have consistently outperformed a tough index (see below). The answer is not many. So we don’t think they are worth it.
• If you still want to invest in them, try a tactical strategy (see below) and avoid systematic investing. At the very least, shift gains periodically, especially when everyone else is talking about small cap funds and their wonders.

Our research on small cap mutual funds.

• Why investing in small cap mutual funds does not make sense!
• Do not use SIPs for Small Cap Mutual Funds. Try this instead!
• Why are you comparing Small Cap Mutual Funds with a Mid Cap Index?!
• Which small cap mutual fund should I include in my portfolio?
• Is it worth buying small cap mutual funds?