05 Dec 2022 • 5 min read
A mutual fund can combine your funds with other investors and have a professional handle the fund. They are in the form of bonds, stocks, and equity. Data from the Association of Mutual Funds in India show that in FY22, the industry welcomed over 10 million new investors and collected Rs 1.2 trillion in total through SIPs. However, you should know the hazards associated with investing in mutual funds.
As mutual funds engage in a wide range of financial assets, including debt, equities, corporate bonds, and government-backed securities (or financial instruments), the risk is there regarding mutual funds.
Numerous factors influence the price of these instruments and have a greater likelihood of losing money than making them. You will almost certainly see losses mounting if you don't stay invested. Therefore, it is crucial to determine the risk profile and invest in the best fund.
You Might Find Interesting - History of Mutual Funds
The risks associated with Mutual Funds are as follows:
An equities mutual fund's investment value drops if the entire market experiences a downturn. They are also known as Systematic risks. A variety of factors impact any security market. Important variables include natural catastrophes, fluctuating interest rates, inflation, recession, conflicts, political unrest, shifting population demographics, and geopolitical concerns.
Depending on the volume of transactions in the market, liquidity risk is the ease with which you can sell an asset or close to its fair value. Another type of liquidity risk was encountered by Exchange Traded Funds (ETF). After their issuance, ETFs are traded on the stock exchange. Finding prospective buyers or sellers of the ETF on the stock exchange is frequently challenging.
Interest Rate Risk
Changes in interest rates impact the price of a security. hedge fundsBond prices and interest rates go hand in hand. So, Bond prices decrease in response to a rise in interest rates. Similarly to this, bond prices rise when interest rates drop. As a result, changes in interest rates affect the financial instrument's value.
Currency risk is the possibility of profits or losses resulting from changes in various currencies. Everyone is susceptible to the effects of currency risk, including governments, international corporations, and tourists traveling abroad.
Based on several factors, the asset is rated by credit rating agencies. Bonds with high ratings pose less credit risk. Low-rate bonds also carry a high credit risk. There is a credit risk when the security issuer cannot pay the interest as promised. Debt funds that invest in bonds with weaker credit ratings run a higher risk.
As the name implies, regulatory risk is a category dependent on government announcements and rules. The value of your investment will be impacted by any law or regulation that could harm the industry in which you have assets.
Concentration risk is the term for having significant exposure to one particular asset, industry, or theme. Concentrating a sizable portion of your investment on a single asset or asset type is not a good idea. Profits might be phenomenal if the market favors the collection of assets. If the tide for that particular item or combination of assets flips, there could also be substantial losses.
The danger of potential loss of your investment's buying power due to an overall rise in consumer prices is known as inflation rate risk or purchasing power risk. Fixed-income investments enable a clear understanding of inflation risk. The nominal return on your investment is if you purchase a bond with a 3% coupon rate. However, if inflation is 2%, your actual increase in purchasing power is only 1%.
Any mutual fund's performance depends on the manager's experience, knowledge, skill, and investment techniques/process. If any of these factors are lacking, the fund's performance will suffer, which will be bad for unit holders.
Mutual fund investments are regularly rebalanced and reviewed by the fund managers. On the other side, frequent reinvestments risk missing out on opportunities for investment growth. Additionally, periodic rebalancing will raise the management fees for the fund.
The best possible ways to overcome Mutual Fund Risks are as follows:
You Might Find Interesting - How Can You Invest in AIF (Alternative Investment Funds)?
Each kind of mutual fund has a unique risk and return potential profile. It's critical to comprehend these risks and potential rewards before investing in a mutual fund.