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Types of Risks Associated With Mutual Funds
Mutual funds are a great investment avenue for both beginners and experienced investors alike. They are widely preferred over the volatile stock markets for their ability to provide inflation-beating returns. However, mutual funds too are not completely risk-free. The popular one-liner disclaimer stating “mutual funds are subject to market risks” might come to your mind.
When it comes to mutual funds risks, very often people are not aware. It is just not enough to look out for low-risk mutual funds or high-risk mutual funds while investing. Instead, you should know about the risks involved with your investments and how they might perform is a key aspect of successful investment. Usually, the documents or the brochures related to a particular mutual fund mention the risks involved with its investments. Ideally, you should go through these documents carefully and try to understand them. Having an understanding of the risks involved in mutual funds is necessary if you wish to sail past such losses, and plan ahead.
What are Mutual Funds?
Let’s start with the basics. Mutual funds pool money from multiple individuals and institutional investors to invest the collected money in a variety of asset classes such as equities, debt and other money market instruments after careful research. Although naturally, they have a goal to maximize capital appreciation or generate income, there are risks involved which might burn your cash and lead you to a state of loss.
What Makes Mutual Funds Risky?
Mutual funds carry risks for the simple fact that they invest money in a variety of spaces, such as debt, equity, corporate bonds, etc. All these spaces behave differently in the markets, with their prices fluctuating depending on a lot of factors which might result in either profits or losses.
This makes it important for you to identify the risk profile and invest in the most appropriate mutual funds. Analyzing the risk profiles of the funds beforehand will help you manage your mutual fund risks and returns accurately.
Types of Risks in Mutual Funds
All investments carry a certain amount of risk. The type of risk may differ from investment to investment, making it all the more important to know about the different types of investment risks.
The best low risk mutual funds invest in government bonds which allow them to offer higher returns to investors with comparatively low risks. Thanks to their risk-free investment portfolio, such funds are able to either match or stay ahead of the economic inflation and are hence considered low risk high return mutual funds.
Moderate risk mutual funds invest in MIP funds, Arbitrage funds, and Hybrid debt-oriented funds. Such funds are recommended to be safe for short to medium term investments, between 1 to 3 years.
High risk high return mutual funds such as equity funds invest the pool of money in stocks or shares of companies. They are usually meant for long-term investments, for more than 5 years.
1. Market Risks
Market risk, also known as systematic risk, is something that might affect your investments due to the poor performance of the market. Market performance can depend on a number of factors, such as inflation, recession, fluctuation of interest rates, the occurrence of natural disasters or something of the sort. Since there is no way to predict what will happen in the future, market risks make up for some of the most important mutual funds risks to be aware of.
2. Volatility Risk
Typically, equity-based funds invest in the shares of companies that are listed on stock exchanges. Thus, the value of such a fund is directly related to the performance of those companies, which might be affected by prevailing economic conditions such as consumer preferences, government policies and more. These factors directly impact the price of the stocks of the company and might result in either upward or downward movement in its share value, leading to considerate mutual fund risks.
3. Liquidity Risk
Liquidity risks come into play when the mutual funds have long-term investment goals and rigid lock-in periods. In such a scenario, it becomes difficult for the investor to redeem an investment without incurring a loss in the value. It can also occur when a seller is unable to find buyers in the market at a suitable time. Mutual fund's liquidity risks should best be avoided with a diverse portfolio.
4. Credit Risk
Credit risk, or default risk, concerns those mutual funds which invest in bonds and debt instruments. When the issuer of the bonds is unable to pay what was promised as interest, then the issuer has defaulted or committed credit loss. Firms with high credit ratings pay less interest and vice-versa.
5. Concentration Risk
Concertation risk arises when investors tend to put all their money into a single investment scheme or in one sector. This leads to the concentration of a considerable amount of a person’s funds in one particular scheme, which is not considered a good practice since it is more prone to losses. A diverse portfolio can help here too, minimizing risks from the downfall of a single instrument.
6. Inflation Risk
Inflation basically decreases the purchasing power of our money. Inflation risks are associated with the rise in the general level of prices of various goods and services that we consume, with time. If inflation is not accounted for properly in the investment plan, the investor might fall short of funds to furnish their goals. This makes it important to make investments in mutual funds that are able to protect purchasing power.
Mutual funds, like any other investment scheme, are subjected to these and more risks at all times. While you cannot avoid these risks completely or the factors that cause them, you can very well plan and invest your money in a way so that the risks are minimized and returns maximized. Mitigate the risks involved by using the different investment strategies and keep investing.
Let us at Muthoot Finance help identify the best mutual funds based on your investment profile so that you can achieve the short and long term financial goals you intend to. Visit your nearest Muthoot Finance branch to speak to our experts.
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