Small-cap funds for big goals: Here’s all that you need to know3 min read . Updated: 30 Dec 2020, 12:05 PM IST
Small-cap funds are great for long-term wealth creation. That’s because they have the ability to compound wealth over time, as small-cap companies cater to niche markets.
We live in a world where we are inundated with an array of investment opportunities. The problem lies in choosing the right financial instrument, and that’s why we are here to help you out. Most people might have heard of small-cap funds, yet do not know how they help. For starters, they are funds that tap into the potential of young and promising companies. You might have to be a little patient, but trust us, if you stay invested, you are sure to reap rewards in the long run!
Before we get down to the details of small-cap funds, it is important to understand the concept of market capitalisation. By definition, market capitalisation is the aggregate value of a company that is derived by multiplying the total number of outstanding shares with the current price. For example, say a company has 30 lakh shares, and they are being traded at a market price of ₹1,000 each, then the market capitalisation of the company stands at ₹300 crore.
What are small-cap funds?
For the uninitiated, small-cap funds are those that have a market turnover in the range of ₹10 crore to ₹500 crore. These are companies that fall beyond the 250th mark in terms of full market capitalisation, according to SEBI.
Why must you invest in small-cap funds?
As we mentioned above, these funds are great for long-term wealth creation. That’s because they have the ability to compound wealth over time, as small-cap companies cater to niche markets. That means you get a high return on capital.
Not many are aware that these stocks are less tracked or under-researched by analysts. Small-cap funds give fund managers the opportunity to benefit from their higher growth potential, because one can select quality stocks over a period of time.
Before you decide to go for small-cap funds, let us tell you that the risk associated with them is certainly higher than even larger firms. This is also because of the low trading volume, but fund managers can certainly mitigate the risks by picking quality stocks, and going for portfolio diversification.
At the end of the day, these funds help to balance the overall portfolio, which is a win-win for the investor.
All you need to know about taxation
Dividend Distribution Tax
Taxation forms an important part of investing in any financial instrument. Initially, the dividends were tax-free, as the company declared the dividend paid as Dividend Distribution Tax (DDT). The dividend proceeds are mandated to be included in the annual income for the financial year, and shall be taxed at income tax slab rates. The Finance Act, 2020 states that the distribution of dividends is subject to Tax Deducted at Source (TDS), wherein the amount of dividend paid on or after April 1, 2020 is over ₹5,000. The rate of TDS stands at 10%. There’s been a change announced by the government post-Covid—a reduction in the rate of TDS to 7.5% for the dividends distributed from May 14, 2020 to March 31, 2021.
Capital Gains Tax
As the name suggests, capital gains that you get from small-cap funds are taxed, based on the duration of the investment (this is also called the holding period). There are various case scenarios here: in case the holding period is up to one year, then the capital gains earned are called short-term capital gains, and these are taxed at 15%. If the holding period is more than one year, and the amount is over 1 lakh, then the assets are taxed at 10%.
Who can invest?
These funds are great for those who want to get higher returns relative to other equity funds, and are willing to take the risk that comes with it. All in all, it’s a good step to balance an overall conservative portfolio with a medium- to long-term investment horizon.
So, if value and growth are on your mind, speak to your mutual fund distributor to choose the right small-cap fund for you today.