Whenever i want to invest in mutual fund, i hear risk level. What is the risk involved in investing in mutual fund? Can we lose money?Asked
Mutual funds are a better and safer option to invest in than other investment vehicles. The reasons for this are:
All mutual funds carry a riskometer which shows the level of risk inherent in a fund. Both equity and debt mutual funds carry risk. However, risk associated with debt funds is less than that of equity funds.
Various equity funds stand in the following increasing order of risks:
In case of debt funds, there are two types of risks- credit risk and interest risk.
Risks associated with mutual funds are:
Ever paid attention to these lines of advertisements of mutual fund companies - “Mutual funds investments are subject to market risk. Please read the offer document before investing “. This disclaimer is mentioned in every advertisement of the mutual fund. It implies there is nothing like zero risk in mutual funds. However, there are various debt funds available which provide low risk to investors.
Mutual funds can be categorized into three categories on the basis of the risks:
High Risk Funds: These funds are the equity oriented funds with high return expectations. The expected rate of return for these funds is above 12 %. Many funds are providing as high as 20 % returns and some even to the extent of 30 %.
Low Risk Funds: These funds are the debt oriented funds with low return expectations of around 6-9 %.
Medium Risk Funds: The funds which provide medium level of risk are the combination of equity and debt funds can be called hybrid funds. They have expected return rate in the range 9- 12 %.
Risk and returns go hand in hand, when the risk gets lower so does the returns. If the risk appetite of an investor is low, liquid funds are considered the safest. Liquid funds are the mutual funds which invest minimum 95% of the investors’ money in liquid instruments that gives a fixed interest for a particular period of time.
Risk is something which needs management not avoidance. The overall risk in mutual funds can be minimized by investing in multiple funds. However, every investment is accompanied by some level of risk and so is mutual funds, it is important to invest them in the right time horizon so that one doesn’t suffer from opportunity loss.
Risk is inherent to investing. Investments vary across the risk spectrum, but there is hardly any investment that's entirely risk-free. The best thing about investing in mutual fund is that it provides you wide scope of investment option depending on your risk appetite.
A mutual fund is an investment instrument, basically collection of stocks and/or bonds, managed by professionals of an asset management company.
There are different 3 major types of mutual funds in India:
1. Equity mutual funds: Invest most of the money gather from investors into stock market. The risk level in equity mutual funds are quite high and investors are advice to invest in these funds as per their risk appetite.
2. Debt mutual funds: Invest most of the money gather from investors into debt instruments like corporate bonds, government bonds, bonds issued by banks etc. These mutual funds are best for investors who are risk averse.
3. Balanced mutual funds: Invest the money gather into both debt and equity. These are diversified mutual funds having perfect balance between risk and returns on investment, and are most popular mutual funds these days.
The level of risk in a mutual fund depends on which investment instrument is picked by mutual fund manager. Generally, higher risk investment fetches you higher returns.
Following are the major risk associated with mutual fund:
Like all investment instruments, even mutual funds do possess some degree of risk.
Risk is lowest when you choose to invest in Debt Funds, and increases as you shift towards equity oriented funds. Below are a few types of risks that are inherent in any mutual fund scheme:
Market Risk: This reflects the correlation between the stock market volatility and the Mutual Fund Performance. The performance of an equity oriented fund will be affected with changes in the stock market, and this type of risk is unavoidable for an equity oriented fund. Investing in debt oriented fund will hedge the investor from this risk, but will also provide lesser returns.
Liquidity Risk: If one particular scheme is not performing well, the fund house may face difficulties in finding buyers.
Credit Risk: This reflects the risk that the company in which the mutual fund invested the corpus will default on the repayment, thereby affecting the investors' return.
Interest Rate Risk: The fund manager may sometimes take a call on the future interest rate, which may or may not align with reality. This hurts the investor because the value of fixed income securities and interest rates are inversely correlated.
Country Risk: Investments are always subject to political changes or instability in the country where the investment was issued. You can read more about the risks involved in mutual fund investments here.
However, it is important to note that even holding cash in physical form is risky as it involves risk of theft, inflation, etc.
Mutual Funds help you maintain a balance between taking suitable level of risk and generating desired level of return.
There are different categories of mutual funds categorised on the basis of risk, return, objective etc. Please find the classification of mutual funds on the basis of risk below:
1. Very High Risk Mutual funds
Under this category lie the small cap, sector, and mid cap funds. These funds have the highest amount of risk and suitable for investors willing to invest for a minimum duration of 4-5 years and are also willing to take high risk. These funds invest mainly in small cap stocks, mid cap stocks or all the stocks of a particular sector or industry.
2. High risk Mutual Funds
Under this category lie the large cap equity funds, index funds and some of the equity oriented balanced funds. These funds are suitable for less risk averse investors willing to invest for a period of minimum 3-4 years. These stocks invest in large cap companies like Maruti Suzuki, HDFC Bank etc.
3. Moderate Risk Mutual Funds
Under this category lie the debt oriented balanced funds and some of the the debt funds. These funds are suitable for investors who are willing to take some amount of risk with their investment and also want to slightly grow their investments along with stability.
4. Low Risk Mutual Funds
Under this category mutual funds like gilt funds, arbitrage funds are included. These funds are safe in terms of investment and their risk level can be compared to that of a fixed deposit in a bank. These funds are suitable for risk averse investors
To read more about the risk involved in mutual funds please click here
“Mutual funds are subject to market risks, please read the offer document carefully before investing.”
Most investors must have definitely come across this disclaimer highlighting that there is risk involved in mutual funds. For that matter any asset class has an underlying risk, and all investors seek to maximize returns while minimizing their risks.
However investors can decide their investments in various investment classes based on their risk appetite. Mutual funds provide various investment categories catering to the risk appetite of different investors.
1. Equity Large Cap- These funds invest in blue-chip companies wherein both the underlying risk and return is low. Those investors who are looking for lower risk may chose these funds.
2. Equity Mid Cap- These funds invest in mid cap companies, wherein there is comparatively higher risk and return.
3. Equity Small Cap- These funds invest in small companies, wherein both the risk and return is the highest. Investors willing to take on higher risks in order to earn higher returns may choose to invest these funds.
4. Debt funds- Investors may choose to invest in Debt funds, wherein the risk the considerably low while providing reasonable returns.
Most mutual fund schemes highlight the risk level of a fund. Since mutual funds invest in a basket of stocks, it avails the benefit of diversification thereby lowering its risk level. Therefore mutual funds are preferred by a lot of investors as they provide stable, high returns at comparatively lower risk levels.