Mutual fund investments, like any other form of investment carries risks. This means that mutual fund investments are not completely safe and there is a risk involved in mutual fund schemes of losing all your money. The fund value keeps changing as per the value of the investments. It goes up when the price of the units goes up and goes down when the price of the units goes down. Thus, the units depend on the price of the mutual fund scheme.
The amount of risk associated with the mutual fund is dependent on in what type of mutual fund you are investing. If the potential of returns is higher than the risk also will be higher. This means that if a mutual fund investment invests into stocks then the risks are higher. This is as compared to investing in any fixed income fund where the mutual fund risk as well as the returns are lower. The common types of risks involved in mutual funds are market risk, liquidity risk, credit risk and currency risk etc.
The Common Risks That Is Associated with Mutual Fund Investments
- Market risk- The market risks are unavoidable and thus could cause the value of the investment to decline
- Risk of liquidity - The fund will not be able to sell in case the investments are going down in value because there are no buyers at the other end.
- Risk of credit - In the case of when a bond issuer is unable to repay the bond then the investment ends up to be worthless
- Interest rate mutual fund risk - When the interest rate rises then the value of the investments into fixed income securities starts to fall.
- Country risk - In case of any instability in the country the foreign investment declines in that country
- Currency risk - If the currency of the country declines in value then the value of the investment falls.
How should You Assess the Risk of Investing Into a Mutual Fund Investment
The best way to assess the risk in mutual fund schemes is to check how much has the returns offered changed from one year to the other. If the returns offered by the fund have varied a lot then this is a high-risk-investment. This is because the performance of the fund is very volatile.
The amount of risk that the mutual fund investment carries with it is dependent on the asset class that the money is invested into. If the return potential is high then the risk percentage is also high. It is important that you have a diversified portfolio.
What causes the mutual fund risk when you invest in mutual funds
The mutual fund investment is done into a variety of instruments and the price of the instruments tends to keep fluctuating. This is because of the change in demand and supply level or inflation or could be because of interest rate change.
Due to this volatility, the net asset value starts to come down and this ends up resulting in loss. The net asset value is the market value of the scheme that one has invested in after deducting the liabilities.
Thus it is very important that you make sure to identify the risk in mutual fund scheme profile and invest appropriately into mutual funds.
Understanding the mutual fund risks in detail
Market risk
Mutual fund investments are subject to market risks. This is something that we have all read when we have opened to check any mutual fund to invest into. The market risk is basically when the investor loses money because of bad performance in the market. There are many factors that could cause the market risks. This could be because of inflation, any political unrest or because of interest rate fluctuations etc. The market risk in mutual fund schemes is also known as the systematic risk. Even if a person has diversified his portfolio then this does not mean that it will save him from the market risks. All that the investor has to do at this stage is to wait for the storm to settle down.
Concentrating your portfolio
Most of them will only focus on one particular type of investment. They would concentrate all their funds into a particular scheme only which is indeed not a smart way to invest your money. If the investor is lucky then he will make profits but if the investment does not do well then one should be prepared for extreme losses. Thus it is important that the portfolio is diversified and one should strictly stay away from concentrating alltheir money into one sector. If the portfolio is diverse then the risk is lower.
The interest rate risk
The interest rate keeps changing based on the lenders who make credit available and how much demand the borrowers create. This is inversely related and if the rate of interest increases then the security price decreases.
Risk of liquidity
The liquidity is the mutual funds risk and return of not being able to redeem ones investment without making a loss. This could happen because there are hardly any buyers and thus the seller is finding it difficult to sell off the security.
If there is lack of buyers in the market then this means that redeeming your investment will not be possible. It is important that you invest in a diversified portfolio because it lessens the liquidity risks.
Credit risk
A credit risk in a mutual fund is when the issuer of any particular scheme is notable to pay as per his promise. The risk in mutual fund schemes are rated by the rating agencies and if the firm is one that is highly rated then they will be paying less but will be secure.
Mutual funds have credit risk. When you invest in the debt funds then the fund manager will incorporate only the securities that are investment graded. But it could happen that in order to make higher returns the fund manager could invest in low-risk securities.
This would cause the portfolios credit risk to increase. So make sure that when you invest into any debt fund have a look at the credit rating of the funds in which the mutual fund invests into.
Variety helps you to minimize the risk when investing in mutual funds
One particular way in which you can check the risk of a mutual fund is to check the performance of the fund year after year. If the performance of the fund is not consistent but varies a lot then this is a high-risk investment.
Do not put all your eggs in one basket. This is the key to mutual fund investments. This is how you could minimize the risk of investments by having a variety of instruments in your portfolio. Make sure that you check with your financial advisor how the particular mutual fund will be beneficial to your portfolio. Do you have something of a similar risk or does the mutual fund offer you a balanced investment option? If the mutual fund fits into your risk appetite is also a key thing that you should consider.
Make investments based on what your preferences
When you invest in a mutual fund you need to be clear about some factors to minimize the risk. The first question is to ask yourself how long you would like to stay invested in the fund.
This will let you take an informed investment decision based on what your individual needs are and what are the mutual funds benefits of particular plan for you. Those who are close to their retirement age will invest into mutual funds with less risk as compared to someone who is just starting his career. So know what your goals are at in what time frame you plan to achieve these goals and this will let you decide the amount of risk that you should be willing to take.
Conclusion- know the mutual fund risk
Mutual fund investments are risky and some of the high mutual fund risky funds could even wash away your entire capital. So take care to choose the risk in mutual fund sip with care based on your needs. Mutual funds let you diversify your risk by investing in different types of mutual funds.
So if you do that, then even if you make losses in one particular fund you can gain it back on another fund.
But take care to know that investing in mutual funds is not like saving into a government security or banks. They are risky anddo not promise you any returns. You could however choose the risks in mutual funds in India based on the type of fund that you choose to invest in.
Mutual fund investments are very risky but still they help to beat inflation. So your portfolio should have some investments into mutual funds. It is however important that you do your homework to know which fund is the most suited for you and for your personal financial needs.
CAclubindia
