Mutual funds that invest heavily in companies that are small, but not micro-size, can be described as small cap funds.

A small capitalization mutual fund primarily invests in small companies. Small companies are usually defined as companies with market capitalization of under $2 billion. The companies in this category are larger than those in the “micro” and “nano” cap categories.

A mutual fund investing in small cap companies will generally experience higher price volatility than both mid cap and large cap mutual funds. Over time, small cap companies as a group have tended to outperform the broader market, so the higher risk is associated with higher return.

It is important to understand that each individual small cap stock has more potential to fail than its counterparts in the mid cap and large cap category. So, having a mutual fund that invests in a broad range of small cap companies will give an investor the upside potential he or she is looking for with potentially lower risk.

A small cap exposure can be part of an overall asset allocation strategy.

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