Five Risks About Investing in Mutual Funds

Risk has to be seen in context with the investor’s financial profile. This includes his expectations with regard to liquidity, assurance of income, safety of principal and returns on investment. A wise investor should consider investing only if the trade-off between these factors is acceptable. Given below are the five types of risk factors to consider before investing in mutual funds.

1. Market risk Market risk refers to the potential for losses due to volatility in the market. Such conditions are caused by the interplay of several factors such as recession, political events, inflation and interest rates.When the market is on an upswing, investor confidence is high. This leads to a surge in stock values creating wealth in the economy. However, during a phase of economic uncertainty, demand contracts and less value is created, contributing to lower returns for investors.Mutual funds can reflect the prevailing conditions in the economy closely. Therefore, investors should carefully study the market before buying or selling.{2D743194-97C2-43F9-BC28-AEC370801ECD}
2. Concentration risk Concentration means relying excessively on one type of asset class. It is akin to placing all eggs in the same basket.Not only can this leave you vulnerable to a market collapse, your returns could also be affected by high expense ratios, depending on the type of funds you invest in. Hence, your funds must invest across sectors.
3. Interest rate risk Interest rate changes are influenced by demand-supply dynamics.  An increase in interest rates may reduce the price of securities and vice-versa.If you are investing in debt mutual funds that invest in bonds, a rise in interest rate will bring down the price of the bond, resulting in losses.
4. Liquidity risk It implies the inability to redeem investments within a prescribed timeframe. Also, there can be situations when you may find it difficult to redeem without incurring losses.For instance, if you are investing in Exchange Traded Funds (ETFs), it may be a little difficult to sell them. This is why you must opt for mutual funds, which can be easily liquidated when you need money.
5. Credit risk Certain mutual funds invest in securities with lower credit rating in the hope of making quick profits. However, this exposes the fund and investors towards credit risk, where the issuer of the security may not be able to pay interest or return the principal amount.

So, it is important to find out about the ratings of the underlying securities of the fund before investing. To conclude Mutual funds offer the important advantage of diversification which offsets most of the disadvantages. Compare its annualized returns to the benchmark to assess whether investing in a mutual fund is worth the risk.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.