Mutual funds are subjected to market risks. Where there is a risk, there is a panic. Most of the investors worry more about risks than the returns. Since money is at stake, tensions and worries are unavoidable aspects. This is the reason we thought about writing a post on risks associated with mutual fund investments. When you are completely aware of these risks, you will be able to plan your investments according to your risk appetite. The risks vary according to the type of fund. Here we will cover all the aspects in a detailed manner.
Equity Mutual Fund
Equity mutual funds can render high returns when the market is strong but it can return low returns when the market crumbles. Thus, the volatility is quite high in the equities segment. There are considerable fluctuations and these influence the net asset value (NAV) of the units. If the stock value comes down, the NAV will also come down.
The management of the fund manager can play a crucial role. If the fund manager is experienced enough to tackle the fluctuations, your investments can generate decent returns. But since no one is perfect, there is no assurance of the returns as speculated. For example, if the fund manager invested a large portion of the corpus in one stock, the risk increases considerably. This is the exact case with sector funds.
Debt Mutual Funds
In debt mutual funds, there are basically two associated risks. The first one is the credit risk. It is possible that you have purchased debt instruments from a company offering an impressive return. But unfortunately, it is unable to pay back the principal and the interest after a certain amount of time. This means the company defaults. In that case, you will lose your money. This is called credit risk, also known as default risk.
The second concern is the interest rate risk. The interest rates are always fluctuating but the fluctuations are rare. If the rate of return on your debt instruments is 8% and the credit interest rates are 10%, you are losing 2% on your investment. This is called interest rate risk and debt instruments are subjected to these.
Balanced Funds
Balanced funds are actually created to moderate the risks by compromising on the returns. However, this doesn’t mean that the returns are low. You can expect decent returns. This is because a portion of the money is invested in equities. This is beneficial and detrimental as well. If the fund manager plans to invest heavily in equities and the market crashes, this will result in a loss.
When we consider debt instruments in the balanced mutual funds, the interest rate risks is a factor. If you have invested for a long-term, and the interest rates rise, the returns will take a toll.
Money Market Funds
First of all, when you can achieve higher returns by investing in equities and debts, why would you consider money market instruments? And if you do so, you are bound to experience opportunity loss. However, if the market is down or you want to park surplus amount for a short duration, money market instruments are feasible, otherwise not.
Another factor that influences money market funds is the inflation risk. If you invest in money market instruments at a return rate that is less than the inflation rate, you will lose your money. In most of the cases, this is the case. If you want to beat inflation, you should consider debt instruments for the short term and equities for the long term.
