Pennlylal explains Mutual Funds

Amrita Parashar
4 min readAug 25, 2020
Courtesy: imagesbazaar.com

Hey hey! Your Pennylal is here with more stories.But today I am having a random thought. I love people in their 20s. Hardworking, ambitious, ready to rule the world. Ok. If we are talking about hardworking ambitious people, let me tell you a story of a guy straight out from his engineering college. Parth — A fresh engineering graduate from IIT Bombay earning about 1.64 lakh rupees a month (yes folks! he was rich). And as mindful as he was as far his spending is concerned, he used to save around 60k per month apart from paying all the bills and sending money home. He found stocks to be an interesting investment option and hence, approached a friend who was an investor.

His friend advised him mutual fund SIPs of some large cap companies, some mid cap companies and some small cap companies and have a diversified portfolio. I know this is a lot of gyan for you to take. So, let me explain each and every term (i.e. portfolio, mutual funds, SIPs, Large cap, mid cap, small cap)

To answer my own question, portfolio actually means collection of investments irrespective of whoever does it (individual, organisation, wealth funds, etc). For example — Parth’s portfolio entirely consists of SIPs.

Now let me answer a very important question — What do you mean by Mutual funds? Or how exactly is money invested in MFs?

To answer this question, let us consider a scenario — for example — Mr. A invests money in the shares of a company. It means that the returns which Mr. A will derive will directly be dependent upon the performance of that company in which he has invested. Now, if another investor. Let’s say, Mr X wants to invest his money but not in the shares of one particular company but multiple companies to save himself from the risk of exposing himself to only one company. In that case, he can approach a mutual fund and the fund managers of MF will invest the amount provided by investor in different companies and provide a cushion for risk of investing in one single company.

Now suppose that Mr X is a salaried employee and cannot pay the mutual fund a lump sum amount for investment. As a solution to this, MFs have Systematic investment plans (SIPs) through which an investor can invest a fixed amount every month in a mutual fund. Note that mutual funds can be Equity funds, debt funds or hybrid funds if we have a long term investment plan.

Its time that I walk you through what do we mean by large cap, mid cap and small cap. Large cap funds are equity funds which invest most of the investors’ money (at least 80%) in trustworthy, strong companies which have an excellent track record. Thus, it can be inferred that Large cap funds can be considered as highly safe funds. Small cap funds are equity funds which invest a large amount of money (at least 65 %) in mid cap companies. Mid cap companies are companies which have a market value (technically called as market capitalisation or m cap) of less that 10 billion and more than 2 billion dollars. Thus, it can be inferred that these companies are performing well in the market but are not as strong as large cap companies. As far as risk is concerned, these funds are moderately safe and moderately risky funds. Small cap are companies which have a market cap of less than $2 billion. These are the riskiest of all funds.

Now, you must be thinking what a moron I am. I gave a short description, mentioned the risk profile but what about the returns? Ok then. Now its time that I tell you that which fund offers how much return. But before I do that just remember a simple rule. The higher the risk the higher is the return and vice versa. Hence, Large cap companies offer the lowest returns (averaging around 7%), mid cap funds offer a return higher than large caps but lower than small caps. In recent times, the mid cap funds offer a return averaging around 10% on an yearly basis. If we look at small cap funds, these offer the highest returns, which average around 14–15 percent on an yearly basis.

Ok. Lets get back to Parth;s story. Now you hight have understood that Parth was smart for he knew that he need to balance his risk and return. Hence, he took SIPs for all the three funds. But, Parth still faced a loss. Can you guess why?

Keep on guessing why.

I am sure this is a lot of gyaan for you to take in. Digest this. So, the next time you invest money in Mutual funds, do consider all these parameters. I’ll be back with Parth’s story till then keep on making me, spending me, saving me and investing me because as you know I love travelling. Signing off is your own Pennylal.

--

--