As a TV viewer, it is likely that you have come across mutual fund commercials that end with the disclaimer: “Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.” Does this disclaimer serve as a deterrent for you to invest in mutual funds because of the “risk factor”? Do you fear the loss of capital due to market volatility, and thus maintain an arm’s distance from mutual funds? If you are answering in the affirmative, here is what you need to know about mutual fund risks.
Decoding market risk
Like any other investment option, mutual fund investments too are subject to varying degrees of risk. The most significant of these is market risk or volatility. Volatility is the fluctuation in the prices of stocks or bonds. That’s because stocks or bonds are market-related instruments that react to economic events such as changes in the interest rate or policy changes, geopolitical events such as war-like conditions, or inflationary risks- where the purchasing power of assets is reduced due to rising costs of goods and services. Volatility is an involuntary risk that all market instruments are subject to.
Different funds, different risks
Different mutual funds contain different kinds of asset classes in order to meet certain investment objectives. To meet these objectives, fund managers take some calculated risks. For instance, while equity-oriented funds may seem susceptible to short-term volatility, they can deliver superior returns beating inflationary risks over the long-term. Equity funds can, thus, be used to create wealth in the long run.
On the other hand, debt-oriented funds such as liquid funds are exposed to a far lesser degree of risk as compared to equity funds and therefore generate returns in line with the risk taken. However, the investment objective of these funds is capital protection and stable returns. The returns in this case may not be as high as equity funds.
Make informed investment decisions
As an investor, the first step you need to take is to assess your own financial goals and chalk out a financial plan. A good financial plan will help you understand how long you have to meet your goals. It helps you set a timeframe and a target.
The final step is to make an informed investment decision according to your risk appetite. Therefore, there is no one-size-fits-all policy when it comes to investing in mutual funds. Each investor must take a calculated amount of risk based on his individual circumstances. For instance, if you are just starting out in your career, you may be more willing to ride the ups and downs in the market to create wealth over a longer timeframe, as compared to someone closer to his retirement who may be concerned about capital protection and a regular stream of income, especially in his retirement years. He may be willing to accept a far lesser degree of risk.
The last word
To conclude, in the words of Warren Buffet: “Risk comes from not knowing what you are doing.” Buffet reinforces that as an investor that you are susceptible to risks only if you are not working with an investment plan and your investment decisions are not in sync with your financial goals. It is fair to say that when you are using your financial goals and the timeframe to meet these goals as a guiding star to assess the level of risk you are comfortable with, some risks may seem worth taking.