Risk Involved in Mutual Funds
People looking for long-term investments with assured results often opt for mutual funds. That too, for all the right reasons. Mutual funds (MFs) have many built-in benefits which ensure that investment grows steadily with viable returns over a period of time.
We are always told, Mutual Funds are subject to Market Risks. But, what does this statutory warning mean?
Also, how do mutual funds set up a stable apparatus to multiply money over time?
Moreover, mutual funds allow investors to purchase a part of a fund which means that they can buy not one but several funds with a limited pool of capital. Since not all investments perform well at the same time, and this is where having several investments helps. If one or more mutual funds do not perform well, that poor performance can be compensated by the performance of others, hence making up for the loss.
2. Mutual Funds meet everyone’s risk appetite
Investments in mutual funds are made as per an individual’s risk appetite since mutual funds offer a diverse range of options to the investors.
These three types of mutual funds cater to everyone’s needs and appetites and yield results that do not disappoint.
- Equity Funds
These are appropriate for those with higher risk appetites as they mostly deal in stocks. These are appropriate for young investors who are working individuals.
- Balanced Mutual funds
These yields relatively moderate results since they invest in both stocks and bonds. These are considered appropriate for those who are in their middle ages and do not have high-risk appetites. Their performance is stable and predictable and does not have room for much loss.
- Bond Funds
These are appropriate for investors who do not want any risk in their investment. They are appropriate for people who are relatively older and are interested in fixed-income investments. They do not perform as well as other mutual funds but they are relatively stable and do not have a scope for heavy losses.
3. A wide range of easily accessible options
The variety offered in the field of mutual funds is immense, ranging from financial planning firms, banks, trust companies, credit unions and many more.
These are extremely easy to access and one can buy and sell mutual funds quickly and as per their needs.
However, selling off mutual funds early is not advisable since, unlike stocks, mutual funds take some time to show substantial results.
4. Managed by Professionals
Managing one’s own accounts seems like a great idea. But, it is fruitless if the investor does not know how to make the best investments. Usually, an average person lacks the skill and knowledge to analyze market performance and ends up making wrong calls when the time is ripe. It is fortunate that with mutual funds, a professional investment expert handles the management of the pooled capital, making smart and profitable decisions after assessing the market performance.
As it is, risks come with every investment option. Unless well-understood, these risks have the potential to drive an investment down Here are six common risk factors involved in Mutual Fund investments:
- Country Risk
Political changes or economic instability in the country where the investments are made affects the yield of MFs. In such a situation, foreign investors can incur losses on their mutual funds issued in the country experiencing an upheaval.
- Interest Rate Risk
This risk can have an effect on fixed-income securities. This happens because the value of fixed-income securities experiences a downfall whenever the interest rates rise. There is an inversely proportional relationship between the two which often goes unexplored but must be properly understood.
- Market Risk
Market risks affect all kinds of mutual funds; so much that even bond funds are not immune to them. Whenever the market experiences a downfall, all investments inevitably experience losses, and so do mutual funds.
- Liquidity Risk
All funds experience liquidity risk if their value is declining. This happens due to the simple reason that funds cannot be sold while they are losing value because no one wants to buy them.
- Credit Risk
Funds involving fixed-income securities can be affected due to credit risks. A bond becomes worthless if the investor cannot repay the value of the bond. When this happens, the investors lose the money they have put into a bond.
- Currency Risk
Changes in the currency rates in the world economy always affect the investments made across the world in various currencies. This is also called exchange-rate risk since it is clearly affected by the changing exchange rates of a currency. In case an investor from India makes an investment in US Dollars, and the Indian Rupee’s value goes up, the investment made in USD experiences a loss. Hence, there is an equal probability of profit or loss with your mutual fund investments and it is important to choose wisely.
Here are the two things you should consider before investing in any mutual fund.
1. Analyze the risk
It is important to see how a mutual fund has been performing in the last few years and what returns it has yielded in the said period of time. It is advised to invest in a mutual fund only if it has been consistently yielding good results. If the results keep changing, there is a high degree of risk involved.
2. Diversify your investment portfolio
A major advantage of mutual funds is the wide range of investment options they offer. Diversifying your investment portfolio is an excellent way to minimize the risks and the losses you may incur.
The ability of mutual funds to give great profits is well-tested. However, it takes an aware and active investor to make the best of them. Patience is also extremely important when dealing with mutual funds since you cannot get results in a short time. You are required to retain an investment before it multiplies.
With proper analysis, risk assessment and consistency, investors can make use of mutual funds to make profits as per their risk appetites.