Risks are an inevitable part of the investing process. However, what you can do is, you can control the amount of risk you decide to take during the journey of your lifetime.
Everything in life that we invest in comes with a degree of risk. Even the decisions you make in life, the paths you choose carry a certain amount of risk, but you still go ahead with them as the rewards weigh more than the risks. Similarly, when you invest in mutual funds, there is some amount of risk involved as well. Remember that no investment is ever risk-free. It is common knowledge that higher risks are associated with higher rewards.
Usually, a person who is reaching retirement age takes on less risk to protect their capital, whereas a young person who is preparing for their future or building a career will take on more risk by riding out the market’s ups and downs as his aim is to build wealth over the long term. Hence, identifying the level of risk you are willing to take becomes a fundamental factor when deciding your financial goals and timeframe for achieving those goals.
Risk in a mutual fund depends on what it invests in. Equities are known to possess a high degree of risk and thus deliver good returns which create wealth in the long run. On the other hand, liquid/debt funds possess a significantly lower amount of risk as it focuses on protecting capital, consequently offering lower returns than equity funds. Let’s discuss now, what are the risks associated with mutual funds.
Types Of Risks Associated With Mutual Funds
- Market risks: When the value of investments declines due to unavoidable factors that affect the market. These factors can be factors such as financial crisis, economic stagnation, government reforms or scams caused by the government that inadvertently affect the funds or hamper a sector thereby giving negative returns.
- Interest rate risks: It is the risk associated with interest rate fluctuations which are linked to mutual funds having large exposure to fixed income securities. They can be either government bonds or corporate bonds. When interest rates rise, the value of fixed income securities/bonds drop. And when interest rates decline, bonds will appreciate.
- Credit risk: When you lend money to your friend and after sometime he/she fails to pay you back that amount, it is called as credit risk. When you invest in a bond fund the money is ultimately invested in some securities which are rated. When the issuer of the bond fails to pay back the required payment it is called as credit risk. Always ensure that when investing in a fund, it should be invested in higher grade investment securities because there are chances that the company can default in terms of paying interest or principal or both.
- Liquidity risk: Liquidity refers to the readiness to sell an asset. When you’re not able to sell and raise money from your investments without loss is called as liquidity risk.
- Sector or concentration risk: Concentration means to focus on one thing. Concentrating a huge amount of investment in one sector may not be a good idea. Mutual funds are sometimes very specific according to the sector. If an investor is invested in a portfolio of stocks which are concentrated or exposed to a single sector, chances of returns doing poorly may be high. An investor should not invest all their money in a single scheme. The best way to avoid such risk is to diversify the portfolio. A portfolio which is highly diversified portfolios is less risky.
- Risk of frequent rebalancing: Mutual fund investments are periodically rebalanced by fund managers and are monitored on a daily basis with fund houses sending regular reports regarding returns on investments. Investors whose portfolios are rebalanced frequently may lose out on growth opportunities when it comes to their hard earned money.
How To Mitigate Risks Associated With Mutual Funds?
Now that we know the different types of risks let’ see how to minimize them.
As the saying goes – ‘don’t hold all your eggs in one basket’, diversification helps to minimize that risk by having a variety of investments in your portfolio. Diversification is the greatest power in a multi-asset fund as it helps you balance your portfolio. A Multi Asset Fund consists of not just 2 but 3 asset classes that helps you aim at generating returns while reducing volatility and risk. The fund invests in Equity, Debt and Gold; thus giving your investment the potential to reap benefits of all the 3 asset classes in a diversified manner. So, as an investor, you get a professional Fund Manager to take care of the diversification needs of your portfolio and have the ease of looking at the performance of one fund in one statement, rather than looking at multiple statements and trying to rebalance the portfolio yourself.
Invest Via SIP
Another way to mitigate risk is to invest through Systematic Investment Plans (SIPs). They are one of the most preferred ways to invest in a mutual fund wherein you pay a set amount every month/quarter/half-year for a set tenure. It helps you to smoothen out the market fluctuations and therefore investments are at a low cost over a period.
- SIP cultivates the habit of investing regularly through discipline
- SIP helps in the power of compounding
- SIP helps in funding future goals
- SIP minimizes risk of volatility
- SIP helps in diversification
Though there are several risks associated with mutual funds, it can be managed effortlessly by remembering to choose your investments wisely with a long term horizon, understanding your risk appetite to match your financial goals and diversifying your portfolio in a way that helps you grow your wealth sensibly.
Happy Investing !
Disclaimer : This blog has been written by the Content Desk at Quantum Mutual Fund. The views expressed in this post are that of the author and not those of Groww