There is always risk incurred in any kind of investment. People often ask, “What is the risk of investing in mutual funds?” Read below to know
Mutual Funds Are Subjected To Market Risks
Ben Graham, the guru of Warren Buffet and the founding father of value investing used to say, “In the short run, market is a voting machine but in the long run, it is a weighing machine.”
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Now imagine you make a large, one-time investment in equity mutual funds and the markets fall by 10% the next day, It might have a severe impact on your investment because naturally, because of active trading in markets, there tend to be ups and downs. Often, there is no logic behind these ups and downs.
How Do We Mitigate Market Risk?
Invest regularly through SIPs instead of a one-time investment.
Read more about SIP here: All About SIP – Systematic Investment Plan
If you have a large amount of money to invest in, park it in a safe portfolio of debt (portfolio of debt mutual funds). Then, transfer monthly from this portfolio to your equity fund. Here are some portfolios that you may consider
What Is The Liquidity Risk?
When you buy a mutual fund, the fund manager of that mutual fund invests money in stocks, bonds, gold, etc depending on the type of mutual fund. So, when you decide to get your money back from the mutual fund, the fund manager sells some of these investments and returns the money back to you.
Now assume you want to retrieve the investments from their mutual funds at the same time. The fund manager will have to sell a large portion to return the back money to you . What if there aren’t enough buyers for these investments at that particular time? Or let’s say, what if markets remain closed for an extended period and fund managers cannot buy or sell?
The risk of such a situation arising is called liquidity risk.
However, this is a very rare situation.
How to mitigate liquidity risks in mutual funds: Diversify across different mutual funds. A portfolio helps you in diversifying across different mutual funds. Another way is to keep some amount in liquid funds.
Consider a situation when an equity mutual fund holds 10% of its total investment in a single stock. And suddenly, that company goes bankrupt or gets into some trouble. The overall value of the mutual fund’s investment can drop because of this setback.
A similar situation can arise with debt funds as well. Companies can default their interest payment or they can even get down-rated with their credit rating.
How to mitigate concentration risk:
Invest in a portfolio of funds instead of a single mutual fund. Here are some example portfolios that you can check out: Portfolios by experts.
Mutual fund investments are subject to risk, but this risk can be managed very easily. Investors who can channelize the risk, can get handsome returns.