Have you ever thought about what the risks are? Well, I would say you haven’t that’s why you landed on this page. Now, when you are thinking to invest your money in mutual funds you need to know about the risks associated with it. These risks are often ignored by the investors but a rational investor is the one who compares the returns with the risks associated with mutual funds investment and then takes the decision.

In this article, a little step is taken in this direction to make you aware of the risks that are associated with mutual funds schemes.  Before discussing the risks, we will start with the meaning of mutual funds and then we will discuss the risk associated with it.

What are mutual funds?

Typically saying, a mutual fund is a pool of money created with the contribution of different investors and managed by a fund manager. The contributed money is invested in different securities such as stock, bonds, gold, etc. Basically, it provides a gateway to enter into the share market with diversified risk and less cost.

Let’s understand with an example-

There are three persons A, B and C. all of them want to invest in share market but facing the following problems:

1. Have only 200 rupees to invest but the share is of Rs. 1000
2.  Do not have knowledge about the financial market
3.  Afraid of volatility of market.

Here comes the role of mutual funds. With mutual funds, all given problems can be solved. The money will be collected from A, B, and C and the investment will be made in securities and units will be provided to them according to their contribution. Thus, A can have units according to his investment, B can avail the benefit of professional management of its funds by the fund manager and C can diversify its risk and can enjoy investing in the share market.

Also, there are some myths related to Mutual funds investment. Read the article to know more

Now let’s know about some of the major risk associated with mutual funds:

Market risk

It is a well-known fact that mutual fund diversifies its risk by investing in different securities. But what diversification of risk will take place when the entire market is performing poorly. Market risk also known as systematic risk is an avoidable risk. There is a number of factors that can affect the performance of market such as inflation, political interest, recession, etc.

Concentration risk

In some mutual funds scheme where the investment is majorly concentrated on a particular sector leads to concentration risk. If the portfolio is just dependent on the performance of only one sector then it involves a high risk of losing money due to the bad performance of that particular sector. It is always advised to have a diversified portfolio.

Interest rate risk

One of the risks associated with mutual funds is Interest rate risk. There is an inverse relationship between the interest rate and the value of debt securities. In other words, when interest rates go up the price of bonds goes down and vice versa. The change in interest rate depends upon the demand of the borrower and supply of credit by the lender.

Liquidity risk

Liquidity risk is also a major risk that is associated with a mutual fund. Liquidity risk refers to the risk when the investor is not able to sell or redeem its investment without incurring a loss in value of the investment. For example the lock-in period of ELSS which result in liquidity risk.

Credit risk

In very simple words, credit risk refers to the risk associated with the default on debt which arises on non- payment by the issuer of the scheme.  Debt mutual funds suffer from credit risk. There are many credit agencies such as ICRA (Investment Information and Credit Rating Agency of India Limited), CRISIL (Credit Rating Information Services of India Limited), etc. which provide rating to the companies based on their creditworthiness. Companies with higher ratings provide higher interest rates to compensate for the credit risk associated with them. Sometimes fund managers get higher returns, invest in these low rating funds which expose investors to credit rate risk.

Inflation risk

Inflation risk is one of the risks associated with mutual funds is refers to the decline in one’s real purchasing power. The risk arises when the investment return fails to provide a real return to the investors means the rate of return from investment is less than the inflation rate. This type of risk is mainly associated with investment having a fixed rate of return.

Currency risk

Currency risk is the risk of depreciation of the currency which negatively affects one’s investment value. In other words, currency risk is the possibility of a decline in the exchange rate which may lead to a decrease in your profit. The currency risk is also known as exchange rate risk. 

It can be concluded that there are many risks that are associated with mutual funds. But there are many investment techniques that are used by the fund managers nowadays to mitigate the risk. You just need to be a little careful and make an effective and efficient decision by taking into consideration the various mutual funds risks.

 In this article, we are going to talk about some myths about mutual funds that are very common among investors.

So let’s start!!!

Mutual funds are only for experts

Mutual funds are only for experts is the first and foremost myth about mutual funds. Those who have expert knowledge about mutual funds can only invest in them. Well, that is not the case, everyone can invest in mutual funds who have the knowledge or who have not. The mutual funds are managed by expert fund managers so there is no need for you to have expert knowledge. Fund managers perform required research and analysis and invest your money.

You need high amount to invest in mutual funds

There is a myth about mutual funds that if you want to invest in mutual funds you must have a large sum of money. Well, that’s not true. Mutual funds provide a great flexible option for investors. You can start investing with only Rs.100 through SIP. So, there is no need to have large capital to invest in mutual funds.

Mutual funds only invest in equity products

It is not true that mutual funds only invest in equity and equity-related instruments. Mutual funds invest in a number of different securities like debt securities, gold, and money market securities such as Treasury bills, certificates of deposit, commercial papers, etc. so saying that mutual fund is an only equity product is totally wrong.

Need to have a Demat account

This is a myth about mutual funds common among people that you need to have a Demat account to invest in mutual funds. There is no prerequisite that you must have a Demat account for buying mutual funds. You can directly invest via brokerage, banks’ financial advisors, etc.

Mutual fund provides guaranteed returns

This is a myth that mutual funds provide guaranteed returns because as you know mutual funds are subject to market risk. Although the risk depends on the type of mutual fund. But there is risk involved so saying that mutual funds provide guaranteed returns is not right.

Mutual funds is only for long term investment

Although it is recommended to invest in mutual funds for the long term to earn better returns there is nothing like that mutual funds are only for long-term investment. There are many options such as liquid funds, short term debt funds, ultra short term funds, overnight funds which are suitable for the purpose of short term investment.

Mutual funds are more risky than stocks

It is a myth that Mutual funds are riskier than buying stocks. Because in mutual funds, investors can get the benefit of diversification leading to mitigation or elimination of risk while investing in shares there is the concentration of risk. Therefore, investing in an individual stock is riskier.

Equity or debt? Don’t choose both

There is a saying that you have to choose either equity or debt, you cannot invest in both. Well, that is not the case. There are options like hybrid mutual funds where the investment is done in both equity and debt. The proportion of allocation depends upon the goal of the scheme. So you can choose hybrid funds and avail the benefit of both equity and debt.

Mutual fund is the only aspirin to all your investment headache

This is totally a myth about mutual funds. Saying that mutual fund is the only solution to all of investing problems is totally wrong. It totally depends on your financial goals and risk capacity. As mutual funds are quite popular these days as a good investment options people just invest in it without understanding their financial goal and analyzing their risk capacity.

Schemes having good past performance always give good returns in the future also

Well, this is a baseless statement that the schemes having a good performance record will always provide good returns in the future also. Because as we know the mutual funds are subject to market risk, therefore schemes can underperform also. Thus, there is no guarantee that mutual funds having good performance records are always going to provide you better returns. Although it is good to look at the past performance of the scheme making your decisions solely based on it is not advisable. You need to understand the process behind the performance of the scheme.

Once invested, there is no need of reviewing of portfolio

This is the myth that after investing there is no need of reviewing it. Because you need to! Investment is not a onetime process you need to review it and assess that are you able to meet your financial goal or not. Although your money is managed by experts they are not reviewing your overall personal portfolio that’s why taking advice from a financial advisor is recommended or otherwise, you can review it yourself.