Are Mutual Funds Safe?
Last Updated : Aug. 11, 2017, 3:22 p.m.
The definition of an investment being safe can vary from investors to investors. While the risk-averse investors would be quite happy investing in an instrument that can assure the safety of the invested capital, the aggressive investors with a greater risk appetite won’t feel safe even if the capital protection is assured. These investors want both safety and appreciation of the capital, with their investment horizon likely to be as long as 10-15 years.
A fixed deposit of 1 lakh for 15 years could give you a sum of₹2-3 lakhs, based on the existing interest rate of 5%-6.50%. Will the proceeds be sufficient to deal with the expenses 15 years down the line? Most probably, No! The inflation will eat into your returns. That’s why you need to think beyond the horizon and go for mutual funds which can give inflation-adjusted returns.
Mutual Funds at a Glance
Mutual funds can be considered as one of the safest investments around. It is due to the fact that the money pooled in a mutual fund gets dispersed across a multitude of equity and debt instruments. By virtue of that, a fall in the value of one security is compensated by the rise in others. In addition, your portfolio is constantly supervised by experienced and qualified fund managers having the ability to judge where to invest to get the maximum out of the invested capital. You do not need to research on the trends, bar graphs and charts as these managers would do that on your behalf and take the right course of action.
Financial Goals & Risk Appetite to Dictate Your Course of MF Investment
Before investing in a mutual fund, be absolutely clear on two fronts- Financial Goals and Risk-Appetite. These two factors actually go on to decide how safer your mutual fund boat can be. There is nothing called guarantee in life, everything is subject to change and failure. And mutual funds are no different. But as you propel in life with meticulous planning, mutual fund investments can also be beneficial when you are clear in your investment thoughts. There can be a topsy-turvy ride in the short-term but the long-term result is likely to be fruitful.
Financial Goals
Financial goals, to a greater extent, dictate the style of an investment. So, if you want to send your kids to IIMs or IITs of the world in about 20-25 years from now, it would be good to say ‘Yes’ to diversified equity mutual funds. These funds, through investments in equity and equity instruments, can lift the investment value to a considerable degree and would thus brighten the scope for the fulfillment of such educational aspirations.
Equity funds may pose a risk in the short-term. However, it is likely that the risks would come down in the long run. SIP, an abbreviated form of Systematic Investment Plan, can help lower down the risk element. It is a disciplined approach to investing in a mutual fund at periodic intervals like daily, weekly, fortnightly, monthly, quarterly, half-yearly and annually.
An SIP immunes the investors from the volatility risks by balancing the portfolio in both rise and fall of the market. So, there is no need to fear when you see a bear run of the market. Meanwhile, if you feel it would be costly for you to trade in equity funds in a surging market due to the price appreciation, you can be proven pleasantly wrong with SIP at work. During the market plunge, a large number of units are purchased at a lower price. And when the market goes up, fewer units are bought at a higher price. Thus, it allows you to reduce the average cost of your mutual fund investment. This is called as rupee-cost averaging, a unique concept an SIP has to benefit the investors.
The ‘Power of Compounding’ is another factor that can help you achieve long-term goals by growing your money over time. If you keep investing ₹4,000 monthly for a period of 15 years, your total investment in all these years would be ₹7,20,000. At an assumed annual return of 13%, the value of your investment is expected to be around ₹22 lakhs, resulting in a gain of approximately ₹15 lakhs.
However, if you want to invest in an instrument offering high liquidity, it would be better to go with debt funds and more so the liquid funds, which invest in relatively safer instruments such as treasury bills, certificates of deposits, commercial paper having a shorter maturity period of about 91 days with no lock-in period requirement.
Risk-appetite
Be absolutely sure of the risk-taking ability you have because a mess here can make you curse the whole life. So, if you have a high risk-taking capability, equity funds would be the one to go with. If someone’s risk-taking ability comes between the low and high ranges, he/she can go for balanced funds, which give the benefits of capital appreciation as well as regular income generation. These funds invest in both equity and debt in a certain proportion as deemed fit by a fund manager in the given circumstances. Whereas, investors with a low risk-taking ability should go for debt funds, which invest in corporate bonds, debentures, and money-market instruments, etc.
However, it is important to correctly assess your risk-taking capacity. The risk assessment can be done taking into consideration the following factors.
Disposable Income
One of the greatest factors to decide the extent of risk you can bear is your monthly income. Greater the disposable income on the hand, higher will be your risk-taking ability. So, you can bear setbacks like a short-term decline in the value of your investments. But people with limited income can be risk-averse.
Daily Expenses
The expenses you make to get your daily routine going could also have a huge bearing on your risk tolerance ratio. Even if the income is on the higher side, the greater expenses could leave you with fewer bucks to invest. In the event of any emergency, the bucks could reduce further and so as your ability to take a risk. However, if you are left with something substantial to invest on after making the necessary expenses, you can take bigger risks.
Age
When you are into the 30s, you are most likely to take bigger risks in investments like equity mutual funds. But as you approach 50, your risk-taking ability comes down and further down after the retirement. This is the time when the focus would automatically shift to fixed income instruments. When you reach that stage, make sure you invest in debt funds and generate a stable flow of income to spend on the day-to-day needs.
Knowledge
Your work does not end by knowing that the fund managers are there to take care of your mutual fund portfolio. Instead, you should try to get a complete detail of these managers, both their past and present track record. Also, it won’t be any harm if you keep a tab on what’s happening around in equity and debt markets and their effects on the mutual fund investments. This will be like a homework for a better MF journey.
Since mutual funds have a wide range of schemes catering to the tastes of several investors with different financial goals and risk-appetites, it would be good to choose them for a better future.
Disclaimer – Mutual Funds are subject to market risks. Please read the scheme related documents carefully before investing