We all know the phrase “mutual funds are subject to market risk” by heart! Some of us might have even heard that “investments are subject to market risk”.
Today, we will be decoding these phrases by understanding the types of risk in investment that you might incur while investing in mutual funds.
Disclaimer: Before we get into it – let us tell you straight off the bat that ‘risk-free investments’ are a hoax! We want you to retain this information because at best, you will find low-risk investment options in the market, but ‘no-risk’ is simply a no-go!
Now, mutual funds have gained popularity among investors in India due to their potential for long-term wealth creation. However, like any investment, mutual funds carry risks. It is crucial for beginners to understand and evaluate mutual fund risks to effectively make informed investment decisions. Investment risk and return are two important aspects of investing wherein the former can significantly influence the latter. So, we put together a list that highlights the various risks associated with mutual fund investments in India and have shared some valuable pointers on how you can manage these mutual fund risks.
Let’s dive right in!
Market risk is the primary risk factor that affects your mutual fund investments. This investment risk refers to the volatility and fluctuations in the overall market. Factors such as economic conditions, geopolitical events, and market sentiments (i.e., the attitude of those investing in the market) ultimately influence the overall performance of mutual funds. Beware, that during periods of market downturns, the value of mutual fund investments can decline significantly.
Managing Market Risk
Here are some important ways in which you can manage market risk –
Diversify – Investing in a variety of mutual funds across different asset classes helps spread the risk. Diversification reduces the impact of a single underperforming investment on the overall portfolio.
Analyze Fund Performance – Historical performance data can provide insights into how a mutual fund has performed during different market conditions. It is important to consider long-term performance rather than short-term fluctuations to accurately gauge mutual fund risk.
Stay Informed – Regularly monitoring market trends and staying updated on economic news can help you make informed decisions. This information can guide you in adjusting your investment portfolio allocations based on market investment risks.
Understanding market risk is important because it has a direct impact on your returns and on protecting your capital investment. Keep in mind that there is no real way to time the market, so don’t waste your breath trying to do just that. Instead focus on disciplined investing for the long term to mitigate market risk.
Credit risk is a type of investment risk that is associated with debt-oriented mutual funds that invest in fixed-income securities like bonds and debentures. This mutual fund risk primarily refers to the possibility of default or delay in interest or principal payment by the issuer. Factors such as credit ratings, economic conditions, and the financial health of the issuer can potentially impact your credit risk.
Managing Credit Risk
Here are some pointers on how to manage credit risk –
Assess Credit Ratings – Credit ratings assigned by rating agencies indicate the creditworthiness (we love that word!) of the issuer. Higher-rated securities generally carry a lower credit risk. Keep in mind (especially if you’re a beginner) – that you should consider investing in funds with a diversified portfolio of securities with high credit ratings.
Evaluate Fund Manager Expertise – A skilled fund manager can effectively help you analyze credit risk and select quality securities. Researching the track record and experience of the fund manager is entirely up to you! It can provide insights into their ability to manage this type of mutual fund risk effectively.
Regularly Monitor Portfolio – As an investor, it is your responsibility to monitor the portfolio holdings of the mutual fund to ensure the issuer’s credit quality remains stable. Timely information can help you identify any potential credit deterioration and take appropriate action to help mitigate this type of mutual fund risk.
Understanding and tackling credit risk is important so you can create a contingency plan to protect your wealth even in case of the issuer’s default.
Liquidity risk is a type of mutual fund risk that arises when you find yourself facing difficulties in buying or selling mutual fund units due to a lack of buyers or sellers in the market. Illiquid securities or sudden redemption pressure can pose liquidity risks.
Managing Liquidity Risk
Analyze Asset Allocation – Funds with a higher allocation to illiquid securities like small-cap stocks or long-term bonds carry higher liquidity risk. Beginners are typically advised to consider funds with a balanced asset allocation to mitigate this type of mutual fund risk.
Evaluate Fund Size – Smaller funds may be more susceptible to liquidity risk as they have limited resources to meet large redemption demands. Opting for funds with a substantial asset base can offer better liquidity management.
Understand Exit Load and Lock-in Periods – Some mutual funds impose exit loads or have lock-in periods that restrict redemption. Beginners should be aware of these terms and factor them into their investment decision-making process.
Understanding and planning for liquidity risks is important because it ultimately affects your ability to cash out from any mutual fund investments you’ve made.
Look, you already know that mutual fund investments in India offer potential growth opportunities – but since they also carry inherent risks, it is prudent to know the potential risk that you are incurring by investing. Understanding and effectively managing mutual fund risks can help you make informed investment decisions.
Diversification, analyzing fund performance, staying informed, evaluating fund manager expertise, monitoring portfolios, and understanding exit loads are essential steps for managing various mutual fund risks.
With a diligent approach and careful evaluation, you can navigate an array of mutual fund risks, and build a robust mutual fund portfolio aligned with your financial goals.
Investment risk refers to the different kinds of risks that are associated with any kind of investment.
Diversification, analyzing fund performance, staying informed, evaluating fund manager expertise, monitoring portfolios, and understanding exit loads are essential steps for investment risk management.
Market risk is the primary risk factor that affects your mutual fund investments. It is the type of investment risk that refers to the volatility and fluctuations in the overall market.
Credit risk is a type of investment risk that is associated with debt-oriented mutual funds that invest in fixed-income securities like bonds and debentures. This mutual fund risk primarily refers to the possibility of default or delay in interest or principal payment by the issuer.
Liquidity risk is a type of mutual fund risk that arises when you find yourself facing difficulties in buying or selling mutual fund units due to a lack of buyers or sellers in the market.