We all know that mutual funds are subject to market risks. However, did you know that there are other risks associated with mutual funds as well?
A mutual fund is one of the popular investment options right now. It can help you with your long term and short-term financial goals. However, before investing in mutual funds, it is essential to know the different risks associated with mutual fund investment.
It is to be noted that all mutual funds may not carry the same risks and in the same proportion. It is because the underlying instruments of mutual funds vary. Equity funds invest predominately in equity instruments, while debt funds invest in debt securities such as bonds and treasury bills. As the underlying instruments react differently to different economic and market events, the mutual funds also respond differently.
These are common risks a mutual fund investor know
Market risk, also known as systematic risk, is a risk that your mutual fund investments may face because of the market’s poor performance. Various circumstances, including inflation, recession, interest rate fluctuations, natural disasters, can influence market performance. It is the common risk for debt and equity funds, and it is essential to consider the effect of market risks, as no one can foresee what will happen in the future.
Volatility risk is mainly associated with equity-oriented funds. Equity funds typically invest in the stock of publicly traded companies on stock exchanges. As a result, the value of such a fund is directly linked to the performance of those companies, which may be influenced by current economic conditions, such as consumer preferences, government policies, and other factors. These factors directly affect theprice of the company’s stock and can cause an upward or downward movement in its share value.
Interest Rate Risk
Interest rate risk is another crucial risk you need to know, especially if you want to invest in debt funds.
Any upward movement of interest rates heavily affected debt funds that invest predominantly in long-duration bonds. When interest rates or the RBI’s repo rate move up, bond prices decline, resulting in a loss of investment value. As a result, you can invest in accordance with interest rate movements, or better yet, align your investment timeline to the average maturity of debt funds.
Credit risk is another risk that mainly affects debt funds. Debt funds invest in corporate bonds and commercial papers issued by corporates and receive regular interest and principal repayment at the end of the tenure. If the company cannot pay the interest or principal back to their investors, the credit rating agencies may downgrade the instrument. As the value of the paper takes a hit, it may affect the overall returns of debt mutual funds. When a firm is unable to pay its interest and service its debt, credit risk comes into play.
The difficulty of redeeming an investment without experiencing a loss in its value is referred to as liquidity risk. You may face issues or may not be able to withdraw money when redeeming from closed-ended mutual funds or mutual funds with a lock-in period, such as ELSS funds.
You may face liquidity issues while redeeming a considerable amount from your Exchange Traded Fund with a low trading volume.
When you put all of your money into a single investment strategy or sector, they run the risk of concentration. This results in the concentration of a large portion of your assets in a single scheme, which is not a wise strategy because it increases the risk of losses. A diverse portfolio can also help reduce the risks associated with a single investment option.
Inflation reduces the purchasing power of our currency. Inflationary risks are linked to an increase in the overall pricing level for the various goods and services we use over time. If inflation is not properly accounted for in the investment plan, the investor may not be able to meet their objectives. As a result, it’s critical to invest in mutual funds that can protect your purchasing power.
So, These are the top 7 common risks a mutual fund investor should know
Risks are inherent in every investment. Therefore, it is imperative for you to know about all types of risks associated with mutual fund investment to understand its impact on your investment portfolio. So, it is indispensable for one to know about the different risks involved in investing in mutual funds.