Many Analysts/ Investors consider investing into small caps because many times small caps outperform large cap. However, it has also been seen that many investors have suffered huge losses because of same.

Let’s understand –What makes small caps riskier from the large caps??

Small caps do provide higher return when compared to large caps — but the main reason for the same is small caps are riskier than the large cap .

This is a fundamental rule in Finance – Higher Returns comes with Higher Risk.

If you take less risk you’ll get less return and that’s large cap.

If you take more risk you will get higher return and that’s small caps.

So small caps provide higher return but at higher risk.

Now let’s understand why the small caps have higher risk.

1. Small caps are generally companies which are having lesser governance as compared to the large cap. Our regulator SEBI or NSE will scrutinize large cap more in detail as compared to small caps. This gives the small cap companies an opportunity to do fraud and not get caught because the level of scrutiny applied by the regulator is lesser.

2. Small cap stocks are generally prone to operators manipulation , small cap stocks share price show a lot of volatility because the share price manipulators (Also called the operators) manipulate the share price. The market cap of small cap company is much lesser and hence it easier to manipulate a small cap company share price as compared to a large cap company’s share price. So many times the small cap company shares are heavily manipulated. A recent example of this manipulation is 3i Infotech or Renuka Sugar

3. Small cap is generally concentrated into one market, which makes a them riskier.

For Eg: A small company may be doing all business from Mumbai market. It has limited marketing tools and limited scale of operation so they are unable to go PAN India. Whereas a Large cap company has enough scale of operation because of which they can go to PAN India.

Now, if a negative event affects the Mumbai market alone, the small company concentrated in Mumbai will suffer huge losses. The large company might not be affected much as they have diversified into PAN India.

To conclude, as Small caps are more riskier, the return potential is much higher as compared to large cap.

During the expansionary market, when the economy is rising, large cap provide reasonable returns and small cap provides awesome returns.

But when the economy is falling or on a recessionary stage, large cap struggle and small caps CRASH.