WeInvest Editor’s Desk

When a mutual fund is described in terms of market cap (i.e. small cap, mid cap or large cap), it indicates the size of the companies in which the fund invests, not the size of the mutual fund itself. Market cap is calculated as the number of shares outstanding multiplied by the current market price of one share. Thus, a company with one million shares outstanding selling at $100 per share would have a market cap of $100 million.

Small-Cap Funds

Small-cap funds typically include companies with market capitalization of less than $1 billion (bear in mind that these numbers are only approximations that change over time, and the exact definition of these categories can also vary between brokerage houses). Generally speaking, smaller companies are those in the early stages of business. They are presumed to have significant growth potential, but are not as financially strong or as established as larger companies.

Because small-cap funds invest in companies that are less stable than large-cap companies, the funds can be quite volatile. This has its advantages and disadvantages. In times of market instability, small-cap funds can suffer greatly as less-established companies go out of business. On the other hand, small-cap funds can also be great investments for those who can tolerate more risk and are looking for more aggressive growth. Investors hoping for aggressive returns will certainly want to park some money behind these funds.

Mid-Cap Funds

The most popular choice among the general investing public, mid-cap funds are those that invest in companies with market caps of $1 billion to $8 billion. Mid-cap companies share some of the growth characteristics of small-cap companies, but they entail less risk (at least in theory) because they are slightly larger. You might say that mid-cap funds are to the mutual fund market what mid-size cars are to the automobile market.

Mid-cap funds dont always move with the broader market, and they are also usually not as prone to violent swings as small caps. Mid-cap funds can be great investment vehicles for investors seeking a fund with great return possibilities without the risk of small caps and index-related returns like those of large caps.

Large-Cap Funds

Large-cap funds comprise companies with market caps of $8 billion or more the big fish of Wall Street. However, because of their enormous size, large-cap funds are often forced to imitate a larger index, such as the S&P 500. This is because mutual funds have restrictions on the level of ownership they can have in any one company, which is generally no more than 10% of their outstanding shares. This results in large-cap funds being forced to buy large companies the same ones that make up the major market indexes.

Large-cap funds can be great for investors who have longer-term investment timelines and would like to buy and hold. But for those seeking greater diversification in smaller, more aggressive companies, large-cap funds probably arent the answer.

Please look at the video below to understand what Market Capitalization means.