With various mutual fund types available in the market, it may be challenging for retail investors to select the correct one. This gets trickier during unpredictable market scenarios. Here’s where two kinds of funds come into play – index funds and mid-cap funds.
Retail investors with moderate to high-risk tolerance levels i.e., those comfortable with a little risk tend to lean toward an active investing approach. In contrast, those with lower to mid risk appetite i.e., those who prefer higher stability often gravitate towards a passive style of investment, which might generate little lower returns but with a high sense of predictability.
So, in the case, you are looking to invest in mutual funds, the major question comes in: should you consider index funds or mid-cap funds? Let’s understand.
What are mid-cap funds?
Just as the name implies, mid-cap funds are mutual funds that mainly invest in medium-sized companies’ stocks. Note that 65 per cent of its assets are invested in mid-sized stocks. Mid-cap stocks are stocks of those companies ranking between 101 and 250 in terms of market capitalisation. Mid-cap funds are actively managed, meaning that fund managers actively seek out promising stocks and opportunities to generate returns higher than the benchmark.
What are index funds?
In simple terms, index funds strive to replicate the exact makeup of a specific market index, like the Nifty or Sensex. For example, the Nifty is composed of 50 stocks. Consequently, an index fund that tracks the Nifty will hold those very same 50 stocks in its portfolio. These funds aim to achieve returns that are consistent with the performance of the benchmark they follow. Unlike mid-cap funds, index funds are passively managed. This means that the fund manager buys and sells stocks according to the benchmark’s composition. The goal is to closely match the benchmark’s performance.
Advantages of investing in mid-cap funds
- Potential for higher returns compared to large-cap funds, while generally being less risky than small-cap funds.
- Active management by fund managers who consistently seek opportunities for greater returns.
Advantages of investing in index funds
- Lower risk compared to pure mid-cap funds, particularly during market downturns.
- Lower expense ratio compared to small-cap, mid-cap, and large-cap funds due to passive management.
- Diversification across all the stocks comprising the chosen index.
Making the choice
For this decision, there is not a one size fit all solution available. Both mid-cap and index funds come with their own merits and drawbacks. Your choice should depend on several crucial factors. Let’s quickly examine a few of them.
If you have a low-risk profile, index funds are often more suitable. However, if you are a moderate, aggressive, or growth-oriented investor, mid-cap funds could align better with your goals.
Active management of mid-cap funds can lead to higher volatility. Yet, in a bullish market, these funds possess the potential for greater returns. Conversely, index funds’ passive approach results in lower volatility but might yield slightly lower returns.
Index funds may need a slightly longer investment horizon than mid-cap funds to completely realise their potential returns.
In the case, you are still grappling with the decision, it is advised to seek help from a professional instead of making decisions you may regret later.