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Are Mutual Funds Safe?

Highlights

  • Is investing in mutual funds safe?
  • Yes, if you do for a long-term, maintain a good asset allocation and understand the risks involved in it

Mutual funds have been a growing medium of investment for many Indians in the last decade or so, today there are more than 2 crore mutual fund investors and 8 crore + mutual fund folios. However, the past 3 years have been a roller coaster with heightened volatility and negative returns in equities and even in some debt funds. When we invest our money the first thing which comes to mind is that, will my money be safe?

“Return of capital is more important than return on capital”

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Thereby arises the question-Is my mutual fund safe?

Consider investing in mutual funds like investing in a business, when we invest in a business which has a higher risk our expectation of returns is also higher. Similarly, when we invest in a business with a lower risk our expectation of returns is lower. So, before we say a mutual fund is safe or not, it should be viewed in conjunction with the return we expect from the particular MF scheme.

Risk-Return Ratio of Different Mutual Funds

Mutual funds can be broadly classified into three types-debt, hybrid, and equity funds. Debt funds are the least risky, hybrid funds have moderate risk whereas equity funds carry the highest risk. Returns are also on the same lines, debt funds offer the lowest returns, hybrid fund return expectation is better than debt funds and equity funds offer an opportunity to make maximum returns.

Lately, even some debt funds which are considered the safest have given negative returns, leading to doubts in everyone’s mind. This has been due to a series of credit defaults in companies such as ADAG group, IL&FS, DHFL, Essel, etc. These can be one of or an exceptional event in an economic cycle that has led to a downward spiral. If we look at the long term returns of debt funds i.e. more than 5 years, all the debt schemes have delivered a positive return. In case of equity funds when we look at returns over the last 10 years, even they have delivered a positive return.

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Thus, we can say a long-term horizon is very important when investing in mutual funds, somewhat like investing in real estate where we buy a property and forget.

Most of the investors who find mutual funds unsafe are those who have had a bad investing experience i.e. they have lost capital. This can be primarily due to these five factors:

  • Wrong asset allocation
  • Not diversifying enough
  • Investing for a short period
  • Investing without understanding the risk
  • Biased advice from a financial advisor

When we invest our hard-earned money, we need to be careful and ask questions regarding the available investment options. We need to keep in mind all the above factors before making a decision.

Mutual funds are safe if one follows the right asset allocation, diversifies, invests for the long term, understands risk, and has a trusted advisor. Unfortunately, many of us dive in before knowing the depth of the water.

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