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Types of Risks Associated With Mutual Funds

10 Mins 22 May 2023 0 COMMENT

Mutual funds are popular investment vehicles that pool money from several investors to invest in different asset classes. They are preferred due to their convenience and the potential for high returns. However, like any investment, mutual funds also have their own set of risks. In this article, we will explore some mutual fund risks and how investors can mitigate these mutual fund risks.

Why is Mutual Fund Investment Risky?

There are several factors due to which mutual fund investment can be considered risky. Mutual funds invest in a variety of financial securities, including equities, bonds, and other instruments. The prices of these assets fluctuate constantly as per the market conditions. This market price volatility of the underlying assets impacts the net asset value (NAV) of the mutual fund portfolio. Hence, the performance of a mutual fund investment is subject to market risks and fluctuations

Moreover, various risks associated with mutual funds can also include the risk of poor investment decisions made by the fund managers or when they fail to predict changes in the market, leading to losses for investors.

Along with these, there are several other types of risk in mutual funds that investors need to understand and conducting thorough research can help them mitigate these mutual fund risks.

Types of Risk in Mutual Funds

Mutual funds have some inherent risks even though they are diverse investing solutions. Some very common types of risks in mutual funds are mentioned below.

Market Risk

Market risk is the risk of the market’s bad performance that may pose a threat of loss for any investor. The market is influenced by several factors. A natural disaster, inflation, a recession, political instability, a change in interest rates, and other similar events can have a significant impact on the market.

Concentration Risk

Usually, to concentrate is to give your full attention to one object. If you're lucky, the profits will be enormous, but the losses will occasionally be stark. Diversifying your portfolio is a good strategy to reduce this risk. Investing significantly and concentrating on one industry is risky as well. The risk decreases as the portfolio becomes more diverse.

Interest Rate Risk

Interest rate risk is typically faced by debt mutual funds. The availability of credit from lenders and the demand from borrowers both affect interest rates. The price of securities could be impacted due to the changes in the interest rates throughout the investing period.

Liquidity Risk

Liquidity risk is when investors find it difficult to redeem their investment without suffering a loss. This risk is faced by mutual funds that have a lock-in period such as Equity Linked Saving Schemes. It becomes difficult to sell the investments when there are not enough buyers in the market.

Credit Risk

Credit risk refers to the possibility that the scheme’s issuer cannot fulfil its interest-payment obligations. Rating agencies typically grade companies that handle investments based on these factors. One will, therefore, constantly notice that a company with a good rating will pay less and vice versa. Credit risk affects mutual funds, especially debt funds.

The fund manager must only include investment-grade securities in debt funds. Yet, it is possible that the fund management will occasionally add lesser credit-rated securities to generate larger returns. The portfolio’s credit risk would rise as a result. Hence, it becomes essential to look at the portfolio composition’s credit ratings before investing in a debt fund.

How to Combat Risks Associated with Mutual Funds

Mutual funds can be a terrific method to diversify your portfolio and invest in the stock market. However, there are complexities associated, just as with any other investment. Here are a few tips that will assist you in combating risks associated with mutual funds:

  • Examine the past performance, costs, and investment strategy of a mutual fund before investing.
  • One of the major ways to combat risks associated with mutual funds is that you may diversify your portfolio by investing in various companies and industries. By spreading out the assets in your mutual funds, you can reduce your overall risk.
  • Even the best mutual funds may experience value adjustments, so keep a watch on your investments. To maintain your portfolio aligned with your investing goals, keep a close check on your investments periodically and make the necessary modifications.
  • With a systematic investment plan (SIP), you can invest in mutual funds over time in little amounts as opposed to all at once. You can avoid having to time the market by investing through SIPs. In its place, rupee cost averaging averages out your investment costs.
  • Long-term mutual fund investing can help to lower the risks associated with mutual funds. It may assist you in navigating short-term market turbulences. The ability of compounding, in which your profits are invested back into the market to reap greater rewards, can also help you generate more money.
Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.