Generally, everyone has a desire to invest in mutual funds. But there is a feeling of fear about it. There is a fear in the mind that their money may get sunk. So, first of all, know that it is true that there are some risks associated with investing in mutual funds, but if they are known once, then investing in mutual funds can be done for good returns. Investing in mutual funds has good returns, but proper understanding is essential. So let us know today the risks associated with investing in mutual funds and how to make the most of it..
Mutual funds are a better way to sidestep market volatility and invest safely in the stock market. But it is not that by blindly investing in any mutual fund plan, you will get the benefit. The implementation of many mutual funds is less than the market's moderate arrangement. Therefore, some precautions are necessary before investing in mutual funds. The many things to remember are that Mutual Funds are long-term investments. So don't expect any significant returns in a year or two. Even if you invest a small amount, do it for a long time. Invest regularly through schemes like SIPs.
You can start investing in mutual funds, but only after certain things are completed. Preferably of all, we should give priority to our life and health. That is, take a term plan and health insurance. After this, you should also have an emergency fund for an emergency. If you complete both of these prerequisites, you can start investing in mutual funds instantly; if it is not, then first fulfilling these conditions. Investing in mutual funds proves beneficial only after a long time. In such a situation, if you need money during this time, then you will first withdraw money from your mutual fund itself. Therefore, the right advice is to arrange for health and emergency funds first, then start investing in mutual funds.
Below are the various types of risks that mutual funds as investment vehicles inherit-
1. Systematic Risk
Systematic Risks are Risks that you cannot avoid. However, although these risks cannot be avoided, they can be managed with proper Asset Allocation. Asset Allocation is essentially creating a portfolio with multiple assets.
2. Unsystematic Risk
Unsystematic Risk, also known as diversifiable Risk/Residual Risk, is the Risk unique to a specific company or industry. Unsystematic Risk can be minimized through diversification in the case of an investment portfolio. Here are the Risk involved in investing in Mutual Funds-
- Market Risks: Market risk is the most common Risk for any investment structure. Market risk is the probability that the market or the economy will decline, causing individual investments to lose value regardless of their performance.
- Absorption Risks: In general, Absorption means focusing on one thing, i.e., a considerable amount of an individual's investment in one specific scheme is not a good option. Profits will be high if fortunate, but the losses will be more. Focusing and investing heavily in one sector is also very risky.
- Interest Rate Risks: Interest rate risk is related to debt mutual funds. It deals with the Risk of increasing interest rates and their effects on bond prices. The well-known inverse relationship between bond prices and interest rates plays a significant part here. Ascending interest rates cause bond prices to fall, thus reducing capital gains.
- Inflation Risks: Inflation risk is the Risk of losing purchasing power. To put it in simple words, if your mutual funds earn 5% per year and the cost of living goes up by 2%, you are just left with 3% as net returns from your investments. This is also known as the real rate of return.
- Liquidity Risks: Liquidity risk refers to the difficulty of redeeming an investment without incurring a loss in the instrument's value. It can also occur when a seller cannot find a buyer for security. In mutual funds, for example, ELSS, the lock-in period may result in liquidity risks. This is because nothing can be done during the lock-in period. In another case, Exchange-traded Funds might suffer from liquidity risks. As you may be aware, ETFs can be bought and sold on the stock exchanges like shares. Sometimes, due to a lack of buyers in the market, you might be unable to redeem your investments when you need them the most.
- Credit Risks: Credit risk means that the scheme issuer cannot pay what was promised as interest. If a bond issuer cannot repay a bond, it may be close to being a worthless investment. In mutual funds, the debt categories directly suffer from credit risks as the fund manager might invest in instruments with lower credit ratings to provide higher returns.
- Uncontrollable factors: As much as mutual funds offer the convenience of investing, investors cannot ascertain the exact composition of a fund's portfolio, nor can they directly influence which securities the fund manager can buy. The fund may be diversified enough, but the investor has no control over the action taken by the fund manager.
- Nation's Risks: A nation's Risk arises due to changes in the foreign economy where the fund has invested. Specific statutory changes or economic instability in the foreign country would affect the fund's returns. This Risk mainly affects overseas funds.
Conclusively, we can say that Investing in mutual funds can be risky. It is always advisable to keep in mind your age, financial condition, and how much growth you want in the future. It helps in deciding your risk-taking ability. Those who take high-risk invest in Equity Mutual Funds, while those who do not want to risk much invest in Balanced Mutual Funds, including Debt and Equity.