Understanding The Risks Associated With Mutual Fund Investments And How To Mitigate Them For Better Returns

Mutual fund investments are a great option for those who want to make high profits with a low risk profile. These funds provide versatile opportunities for growth and diversification to investors of all kinds. Moreover, you can also choose from an array of different types such as debt funds, equity funds, ELSS, hybrid funds, etc. However, all of these mutual funds come with their own innate risk profile that you should be aware of prior to investing. Let us discover these risks associated with mutual funds and find out practical tips on how to mitigate them with seamless ease.

The inherent risk in mutual funds primarily arises from their investment in a range of financial instruments, including debt, equity, and corporate bonds. The value of these investments can change due to factors such as market volatility or interest rate changes. These could potentially lead to short term losses that you may want to avoid.

One of the most common reasons for a decline in investment value is a drop in the fund’s net asset value. So while different types of mutual fund schemes have varied risk profiles, familiarising yourself with these can help you navigate the complexities of mutual funds with much more confidence.

• Mutual funds provide opportunities for growth, but investors must be aware of risks like volatility and interest rate changes.
• Debt and equity funds each come with distinct risks, such as credit risk and liquidity risk, respectively.
• Diversification, investing through SIPs, and knowing about your risk appetite are effective ways to manage mutual fund risks.

Mutual fund risks can be broadly classified into two categories. These include systematic risk and unsystematic risk. Let us explore the different types of risks associated with mutual fund investments below:

Risks associated with equity mutual funds

The following are a few of the risks associated with equity mutual fund investments:

• Volatility risk: Equity mutual funds invest primarily in the shares of publicly listed companies. The value of these funds is closely tied to the performance of these individuals companies, which can be influenced by external factors such as government policies, regulatory changes, and market cycles.
• Liquidity risk: Investments in mutual funds with a mandatory lock-in period such as equity linked saving schemes can pose some liquidity risks. This means that investors may struggle to redeem their investments without incurring additional losses before the lock in period has elapsed.

Risks associated with debt mutual funds

The following are a few of the risks associated with debt mutual fund investments:

• Interest rate risk: Interest rate risk is a critical concern for debt mutual fund investors. When interest rates fluctuate, the value of debt instruments also changes. For example, when interest rates rise, the prices of bonds usually fall which results in a decrease of the overall value of the investment.
• Credit risk: Credit risk arises when the issuer of a debt instrument fails to make their interest payments as promised. While fund managers usually invest in high quality and credible securities, they may include lower rated options to enhance returns. This practice may increase the risk of default and potential loss of capital for the investor.
• Inflation risk: Inflation risk affects your overall purchasing power. If the returns on your investments do not keep pace with the rising rate of inflation, your real returns would diminish. For example, if your investment provides you a 5% gross return while inflation is at 3%, this would mean that your net gain is only 2%.

Other Risks

Here are the other risks associated with mutual fund investments in India:

• Concentration risk: This risk occurs when investors place all their money into a single scheme or sector. For example if you invest only in one company's stock, it can lead to capital loss if that company underperforms.
• Currency risk: For investors holding foreign currency funds, swings in exchange rates can impact returns. A decrease in the value of the foreign currency can lead to lower returns when converted back to Indian rupees.

Fund managers regularly rebalance mutual fund investments to optimise their long term returns. However, this process can sometimes result in missed opportunities for growth if the market moves favourably during the rebalancing period.

In this regard, you can make the most of your mutual fund investments by building a well diversified portfolio, taking into consideration your investment horizons and risk appetite, leverage the use of SIPs and STPs, etc. However, while these risks are an inherent part of investing in mutual funds, they can be effectively managed through informed decision making and strategic financial planning with a short term vision.

Begin your investment journey on the Bajaj Finserv mutual fund platform. Avail yourself of over 1000 mutual fund schemes, compare mutual funds, and make use of the Mutual Fund Calculator to ensure you make the most out of your mutual fund investments.