Why Are Mutual Funds Subject To Market Risks?
‘Mutual funds are subject to market risks. Please read the offer documents carefully before investing.’Sound familiar? Yes, this is the warning you hear during advertisements for mutual funds. But don’t let them deter you from investing in mutual funds.As all seasoned mutual fund investors know, risk and returns go hand in hand.
Understanding mutual funds
Mutual funds are financial vehicles for many investors to come together and pool their money. This pooled money is invested in the market by a dedicated fund manager. The fund manager invests in a variety of financial instruments to ensure optimal returns.
Depending on your appetite for risk and your financial goals, you can choose to invest in a wide variety of mutual funds. An investor who wants high returns and is willing to accept the riskcould invest in equity or equity-oriented funds. On the other hand, debt relief funds are a safer bet for more conservative investors. Can you get the best of both worlds? Go ahead and opt for hybrid funds. These combine the growth potential of equity funds with the safety of debt funds.
Risks associated with mutual funds investment
You take risks in life when you know there is a chance you might succeed. But there is always a chance that you could fail. This is true formutual funds investment as well. Keep the following risks in mind before you start investing:
1. Volatility: Equity and equity-oriented funds tend to be more volatile since they invest directly in the shares and stocks of a company. When markets are volatile,the Net Asset Value (NAV) of your fund could fluctuate. NAV refers to the fund’s per-share market value. If this value falls, you could incur a loss.
2. Concentration: An effective way to tackle unstable markets is to diversify your investments. So, spread your investments across various sectors and categories of mutual funds. If a majority of your investments are concentrated in a single fund or sector, you could lose a lot of money if that fund or sector does not perform well.
3. Credit risk: This risk emerges in the case of debt funds. Agencies like CRISIL and ICRA provide credit ratings which define the quality of your debt funds. Suppose a company whose shares have been purchased by your fund defaults on its interest or principal amount payment.This will negatively affect your fund’s performance.
4. Interest rate: Debt funds that invest in government securities and bonds carry interest rate risk. During the period of your investment in such funds, the interest rate may fall or rise. A rise in interest rates would signal a dip in the prices of bonds and securities. This would bring down your investment value as well.
Mutual funds investment has both advantages and disadvantages. But they remain a steady and reliable avenue for investment. To keep the investment risks at bay, it helps to carry out thorough research before choosing a mutual fund scheme. It may be a good idea to open an account with a financial institution like Kotak Securities that has a dedicated research team. You could then access their research reports on the top mutual funds and make the right picks.