Is This the Right Time To Invest In Small Cap Funds?

Many financial experts believe that 2010 and 2011 may well be the best time to overweight your portfolio with small cap funds and individual equities. Simply put, a small cap mutual fund is a professionally managed investment instrument which holds a diverse portfolio of stock in smaller businesses with relatively low market capitalization. Don’t let the name fool you into thinking that you are investing in mom and pop-style companies; any business with a market capitalization under two billion dollars can be included in a small cap fund.

What Is The Advantage Of A Mutual Fund?

Small cap mutual funds are a better investment instrument than individual stocks for people with little experience in the stock market. Buying an individual stock requires that a great amount of time be invested in research into that particular company. Even if the sector that a company operates in does well, an individual company could still lag far behind, or even fail completely, because it is poorly managed, under-capitalized, or simply produces an inferior product compared to its competitors. Mutual fund managers perform all the needed research and are much better qualified at separating the exceptional companies from the rest of the pack.

Fund managers are also experts at diversification. The key to a successful fund is to own stock in companies across a broad range of sectors in order to diversity risk. That way, when for example, the biomedical industry falls into a slump, the losses sustained are compensated for by gains in a booming sector, for example in mining or transportation. Mutual funds are also highly regulated and operate under strict rules which are designed to prevent reckless speculation and excessive risk of capital.

Why Small Cap Equity Funds Now?

If the conventional wisdom that the economy is starting to rebound holds up, small cap companies should fare much better than large cap businesses. While the stock prices of large caps and blue chip companies have been hurt during the recent recession, shares of small cap companies have been decimated because they had fewer resources with which to ride out the financial storm and were perceived to be in greater risk of failing completely. When business begins to pick up again, smaller companies who have demonstrated the ability to thrive in the new economic reality will see their share prices quickly recover to pre-crash levels and beyond, generating much higher percentage gains than those companies whose stocks suffered less.

It is important to keep in mind, however, that this scenario only holds true if the economy is in a sustained upturn. If you believe that we are headed toward a second dip in the recession, small cap investing would not be advised.