Catch ’em young, but be prepared for a rollercoaster by Priya Sunder

We all get swayed with the returns on the small-cap index. Small-caps are perceived to grow faster than large-caps because their value has not yet been unlocked, and hence their nimbleness can provide a growth trajectory much higher than the slow, ambling, mammoth large-caps. We all hope to discover a multi-bagger like an Infosys or Titan by catching them young. For an investor, what could be more fun than the thrill of the chase?

However, these stocks are in the early stage of business and hence may not be as financially sound as their large-cap peers. They may suffer much more than largecap stocks in times of market turbulence. Further, not many analysts research these stocks deeply and the level of publicly available information is less. You need to have the commitment to ride this rollercoaster for more than five years, assuming the general economic environment is favourable.

There is a difference between trading and investing. In trading, speculators play a zero sum game. For every trade, you need two participants. For each participant who feels it is the right time to sell a stock, there is another who feels it is the right time to buy that stock. Fast forward six months. If one has made money on the stock, the other would have lost money on it. Hence, in the short term, for every winner there has to be a loser.

In trading, how do we ensure that we are on the winning side? You need three things — the winning troika —to be a stock market ninja: Time, money and access to information. Time, because a lot of effort goes into analysing annual reports and running the numbers. Money, because we need a lot of it to sustain any meaningful trading strategy. Lastly, access to information, because it is not just about researching a company’s financials, reading the papers or getting tips from investment gurus on television. It is having deep insights into the company’s financial health and future goals by interacting with the right people and collating the right information to make the right decision.

For most of us, time is scarce because we have demanding day jobs. Spending endless hours trading on a terminal is not conducive to getting that big promotion next year. Accessing information is tough too, because big investors can open doors to senior management that remain closed to small investors. Unfortunately, therefore, we are more likely to end up on the losing side, compared to the heavy hitters on Dalal Street.

Further, you need the winning troika in even greater measure if you are buying small cap stocks. The best way to invest in small caps is therefore through a mutual fund.

The fund manager, as a big investor, has access to resources and information that can really put your money to work.

Medium and long-term goals should be taken care of by investing in diversified mutual funds in line with your required asset allocation. About 80-90% of your investible surplus should be directed towards such funds.