What Are the Risks Associated with Mutual Funds?
8 August, 2024
Synopsis
Mutual funds are relatively safe but not risk-free investments. Common risks faced by mutual funds include market fluctuations, stock/sector concentration, inflation, liquidity, and interest rates, in addition to credit risk.
Investors can minimise risks through diversification across sectors and asset types, seeking expert advice from SEBI-registered financial advisors, and by strategically switching investments as and when objectives are met.
The HDFC Bank SmartWealth App offers a user-friendly platform for investors to start investing in mutual funds. The app's highlight is that it helps investors choose options that align with their risk tolerance and investment objectives.
Most of us must have watched a cricket match at some point in our life and observed that batsmen take risk to play a reverse sweep or a scoop over the wicketkeeper. The gains are a four or a six! Batsmen know there is a risk of getting out, so they try to play these shots to areas where there are no fielders – that is, they try to minimise risks but do not stop taking risks. Such calculated risks enable the batsmen to achieve their dreams of taking their team to victory.
Similarly, to achieve your dreams, you take on the market risks to get decent returns. So, like batsmen, all you have to do is try to eliminate risks as far as possible.
Are Mutual Funds risky?
Mutual funds invest in markets governed by many factors – domestic economic conditions & policies, political happenings, geopolitics, global economic scenarios, wars, weather, etc. Many of these factors are unpredictable. Thus, clouds of uncertainty constantly hang over the markets, and these clouds introduce drops of risks in market investments. For this reason, before investing in mutual funds, you are told – "Mutual fund investments are subject to market risks. Read all scheme-related documents carefully."
Types of Risks associated in investing in Mutual Funds
Market Risk: Multiple external factors - natural disasters, recession, political changes, interest rate changes, geopolitics, policy changes, etc. – impact market performance, impacting return on investment.
Concentration Risk: This arises when you put all your investments in one basket. For example, you invest all your money in sector A, and sector A goes into recession. In such cases, you lose heavily. Diversification across sectors helps in reducing this risk.
Interest Rate Risk: Fluctuations in interest rates impact debt mutual funds more than equity funds. Volatile interest rates impact debt instruments in your portfolio and thus affect returns.
Inflation Risk: High Inflation impacts net returns on your investments. For example, if you get a 12% return, and the inflation rate is 6%, then your net return is just 6%.
Liquidity Risk: A mutual fund cannot sell some securities in its portfolio. This results in losses for the scheme, which directly impacts your returns.
Credit Risk: Consider the scenario when the bond issuer in your mutual fund portfolio does not meet its commitment. This default impacts the fund's performance and, thus, your returns.
How can you minimise the risk involved in investing in mutual funds?
Diversification: Spread your investments across different sectors and different types of assets in schemes of different mutual fund houses.
Expert Advice: Consult a SEBI-registered financial advisor who will construct a portfolio that aligns with your investment profile and financial dreams. Never make a decision based on hearsay or social media advice.
Switch Investments: Reduce risks by switching to safer options after achieving your investment objectives. For example, reduce equity exposure and invest in debt instruments.
Mutual fund investments are subject to market risks, but you can avoid them with intelligent strategies and expert advice. Even with risks, mutual funds are among the safest investment tools that give you decent returns. Fear of risks should not deter you from investing in mutual funds, as these investments help you achieve your life and financial targets. One of the most straightforward and seamless ways to start your mutual fund investment journey is using the HDFC Bank SmartWealth App.
Download the SmartWealth App from the Play Store/App Store. The SmartWealth App will guide you in choosing a pocket-friendly option from a bunch of expert-rated top mutual funds based on your risk tolerance and investment objectives.
Disclaimer: This communication has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. HDFC Bank Limited ("HDFC Bank") does not warrant its completeness and accuracy. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument / units of Mutual Fund. Recipients of this information should rely on their own investigations and take their own professional advice. Neither HDFC Bank nor any of its employees shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this material. HDFC Bank and its affiliates, officers, directors, key managerial persons and employees, including persons involved in the preparation or issuance of this material may, from time to time, have investments / positions in Mutual Funds / schemes referred in the document. HDFC Bank may at any time solicit or provide commercial banking, credit or other services to the Mutual Funds / AMCs referred to herein.
Accordingly, information may be available to HDFC Bank, which is not reflected in this material, and HDFC Bank may have acted upon or used the information prior to, or immediately following its publication. HDFC Bank neither guarantees nor makes any representations or warranties, express or implied, with respect to the fairness, correctness, accuracy, adequacy, reasonableness, viability for any particular purpose or completeness of the information and views. Further, HDFC Bank disclaims all liability in relation to use of data or information used in this report which is sourced from third parties.
HDFC Bank is a AMFI-registered Mutual Fund Distributor & a Corporate Agent for Insurance products.
