I want to invest in the mutual funds that have the lowest risk. Is it good to invest in such mutual funds? How much return can one get from such funds?Asked
Different types of Mutual Funds have varying levels of risk. Broadly, mutual funds are of the following types:
Equity oriented funds invest a large part of their corpus (at least 65%) in equities. This exposes the investor to volatile nature of the stock market. A stock index never moves in a straight line, so investors need to be ready for the volatility. Investment in such funds is suitable for investors who are comfortable with taking risk. Equity schemes are exposed to not only have Market Risk, which is the risk of the Net Asset Value (NAV) of the scheme going up and down along with the stock market but also Fund Manager Risk, which is the risk that the fund manager will underperform as compared to the benchmark.
Even within equity investment, risk may vary depending upon the size of the company as measured by its market capitalization. Accordingly, large cap companies expose the investor to relatively lesser risk as compared to small cap companies.
Debt oriented funds are comparatively less risky as a major portion of the investment goes towards debt securities. Because debt securities are the least risky instruments available, debt oriented funds too, offer less risk. However, they are not entirely devoid of risk. Even debt oriented funds are exposed to at least Interest Rate Risk, i.e., the risk of the Fund Manager's interest rate estimations going wrong; Credit Risk, i.e., the risk that the borrower will default on the payment and Liquidity Risk, i.e., inability of the mutual fund house to meet the redemption requirements of the investors. To understand these risks in further detail, click here.
Thus, to answer your question, debt oriented funds and large cap companies within equity oriented funds offer lowest risk.
There is no investment option that is entirely risk free. However, there are investment options that will expose you to lower risk than the other options will. In India, mutual funds with lowest risk are debt funds. Debt funds are funds that invest at least 65% of the total corpus in debt securities such as Government bonds, gold funds, fund of funds, and international funds, etc.
However, low risk mutual funds come with trade off. Low risk generally translates to low returns. Debt Funds do not have a Fixed Investment Horizon. You can invest in a Debt Fund for a period of one day to a period beyond 3 years.Though they have provided higher returns as compared to Fixed Deposits consistently in the past, investments in low risk funds are made in debt markets and are more suitable in the short run as investors can invest in equity oriented funds in the long run to benefit out of volatile nature of stock market.
These funds are preferred investors looking for steady income and minimal risk, or by investors who want to accumulate a certain amount by a specified date to meet an objective like paying for their child's education, buying a home, etc.
Although Debt Funds come with minimal risk, it is important for the investor to understand the associated with them. Debt funds are subject to at least the following types of risks:
You can read more about debt funds here.
Among the different types of mutual funds, Liquid Funds / Ultra Short term funds / Equity Arbitrage funds have the lowest risk.
Liquid funds invest in money market instruments and securities with very short term to maturity (less than 90 days). They are not highly sensitive to interest rate movements and provide stable returns to investors. If you have an investment horizon of less than 6 months, then you can consider investing in these funds.
Ultra Short term funds allow you to invest in fixed income and debt instruments with short term maturity again. One can keep the investment from less than a year up to 3 years in these funds.
Equity arbitrage funds also invest in short term maturity debt securities and money market securities and hence have very low risk. If you have an investment horizon of less than a year, then you can consider investing in these funds. Capital gains tax for these funds is usually 15%.
There are a variety of mutual funds available in the market. The returns you will get depends on a number of factors such as your investment objective, risk that you are willing to take, duration of your investment, type of mutual fund. So you need to look at all these factors before investing. Based on duration and risk, various mutual funds option available are:
Low duration (1 year)
Medium duration (3 years)
Long duration (5+ years)
Equity funds are best option if you are looking to invest for more than 5 years. Further you have various options depending on whether you are investing in small cap, mid cap or large cap funds.Investment in these again depends on your risk appetite and investment objective. Expected returns is between 12% to 20%. Various funds that you can consider are:
There is always risk involved when you invest in mutual funds. So take due diligence while investing.
You can read more about low risk investments on this link.