Risks of Mutual Fund investing
Could you lose money if you invest in mutual funds?
Yes, most mutual fund products (except capital guaranteed funds) have underlying assets (Equities, Bonds etc.) that fluctuate on a daily basis. Hence capital loss due to lower prices of the underlying assets or default on bonds is possible. Investing according to an asset allocation plan, having enough exposure to other capital guaranteed investment such as FDs, Government Guaranteed bonds etc., can to a large extent mitigate these.
Are there any risks involved in investing in mutual funds?
You may have seen commercials of mutual fund schemes that end with a disclaimer: "Mutual fund investments are subject to market risks ... ". This is true. Like any non- guaranteed financial instrument there are various risks involved in investing in mutual funds such as:
Price Risks: Fall in the prices of the underlying shares/bonds lead to a lower NAV.
Liquidity Risks: Markets being shut for a long period could lead to the suspension of repurchase / redemption of investments.
Default Risk: Bonds of a particular company defaulting on repayment affecting income/debt/hybrid funds.
Credit Risk: Bonds of a particular company being downgraded by the rating agencies cause lower prices.
The best thing about mutual fund is that in reality most if not all financial instruments carry these risks but public is ignorant about it. For example, bank deposits are guaranteed only up to one lakh rupees. Company FDs carry default risks. Price risk is the only additional risk of investing in a MF. This is true for any investment that has a market price (Real estate, Shares, Gold, etc.,).
If there are risks with mutual funds, can only people with high-risk tolerance invest in it?
No. The biggest risk is not investing at all, as inflation erodes the value of money and the future looks far from certain. Hence proper risk taking and planning are essential.
There are ways and means to mitigate the risks:
- Have equity MF exposure within your risk tolerance.
- Ensure debt MF exposure is well spread out.
- Have adequate exposure to debt assets outside of MFs such as FDs, Govt bond such as PPF, POMIS, NSC, RBI Bonds etc.,