We have all heard the statement "Mutual funds are subject to market risks" as a part of disclaimer. What are these risks?
Risk is basically uncertainty. When you invest your time or money or energy into something even though it is uncertain, you are taking a risk.
Among a plethora of asset classes like FDs, real estate etc. mutual funds and especially Equity mutual funds are considered as the riskiest. However, since they provide higher returns than all other investments, mutual funds are highly favored. Given below are some risks that mutual funds generally face.
A systematic risk refers to the risk that affects the whole financial system. It is almost impossible for you to protect yourself against such risks. Any event or disaster that changes the mindset of people and causes the economy to fall is categorized as systematic risk.
Non – systematic risks:
It refers to volatility of an investment and factors that can make an investment volatile (like currency rates, debt etc.). Volatility refers to fluctuation in the prices and can also mean that we might end up with better returns. Investors usually look into a fund's past performance before investing in it to check how volatile the fund has been. The more often the price changes in a security, the more volatile it is. On the brighter side, instruments that are more volatile provide higher returns.
To reduce the risk of volatility, investors are advised to diversify their portfolio or invest in a mutual fund with diversified portfolio.
Risk that is associated with redeeming an investment is termed as liquidity risk. When getting rid of a fund, the buyer may not be willing to accept the price you quote especially if it's a declining fund. Therefore, it's important to invest with funds with better prospects.
If you have invested in a foreign fund, the political and economic changes of the foreign country could affect your fund and cause it to decline
This is a result of globalization. Funds that are denoted by foreign currencies could decline if the currency in which it was issued loses its value.
Timing and performance:
The returns in a mutual fund depend upon the performance of the fund and the time at which it was invested. For example, if you happen to invest in a bear phase, the prices would fall in future and returns would be low. Hence, it is important to invest at the right time.
Also, the performance of a fund does not depend on its past performance since it depends entirely on the market movement.
Debt funds and bonds are directly linked to the interest rates and so any fluctuation in the interest rates affects them immediately. However, equities and index related funds are not affected by changing interest rates.
There are many more minor factors that cause uncertainty themselves. But still, mutual funds are favored because they generate more income while providing for channels to compensate for risks. Taking guidance from an expert can be very helpful. Also, in mutual funds, fund managers do the job of managing your portfolio expertly while mitigating risks.