Mutual fund great investment option, but fraught with risks

Last Updated : March 7, 2020, 2:28 p.m.

There is always a desire to maximize savings to deal with unforeseen circumstances of spiralling expenses eating away your income substantially. You must be mulling several saving options to build an investment portfolio that can help you stay afloat in the times of uncertainty. Saving options such as bank accounts, fixed deposits, recurring deposits and life insurance are known to many. But mutual fund, despite being its history more than 5 decades old in India, is not familiar to most of us. The reason could be the lack of awareness and less promotion of the product. But, mutual funds can offer you a series of benefits such as professional management of the funds, diversification, affordability, rupee-cost averaging, transparency regulations, etc. Details of these benefits are illustrated below.

Professional Fund Management

Mutual funds are managed professionally by fund managers who distribute your investment across different securities. Depending upon the market conditions, the fund managers keep shuffling your investments from equity to debt to money market instruments.

Diversification

The greatest advantage that comes with mutual fund is its diversification that help cut down the risk factors of interest rate fluctuation, downfall in the market triggered by macro-economic factors, etc. Mutual funds are dispersed across different securities to offset the such risks.

Affordability

With Systematic Investment Plan (SIP) in place, mutual fund investors can invest by paying a sum of Rs 500 every month and create a big pool of money during the time of maturity. But, it is necessary you take the SIP for a long-term to generate maximum money.

Rupee-cost averaging

You invest a specific amount at frequent intervals irrespective of the unit price of the investment with rupee-cost averaging. Thus, your money purchase more units when there is a low price and lesser units in times of high price. This will mean a lower average cost per unit over a period of time.

Transparency

Mutual fund investment is regulated by the Securities and Exchange Board of India (SEBI), the market watchdog, to ensure transparency and boost confidence among investors.

No doubt there are a lot of benefits with respect to mutual funds, but there are risks as well. Hearing this could make you relate to the television ads, saying “Mutual fund investments are subject to market risk. Please read the offer document carefully before investing”. Here’s the list of risks that you must be aware of before investing in mutual funds.

Macroeconomic Risk

Mutual funds invest in stocks that are sensitive to the macroeconomic factors. So even if things go smoothly in the domestic market, but the turbulence overseas can shatter the confidence of investors and thus trigger the collapse in stock prices, resulting in lowering your Net Asset Value (NAV). As long as the national and international economies are doing well, there would be a positive impact in the stock prices and NAV.

Liquidity Risk

Next comes the liquidity risk as there could be some illiquid stocks in the portfolio. The liquidity risk can get accentuated if you have invested in small cap stocks unlike large cap counterparts where the problem of liquidity is not there. Also, we all know how volatile the equity market can be. So as an investor, you should keep in mind the volatility factor before investing in equity funds. And risk is not limited to equity market only as the interest rate risk is prevalent in debt funds. Interest rates and bond prices are inversely proportional to each other. So when the interest rate is lower, you could see some debt funds climbing up and some not performing well. The same thing happens to the debt funds when interest rate rises.

Credit Risk

When you put money in a bond fund, the money is eventually invested in certain securities. Bear in mind that every security comes with a certain rating. So while you invest in a fund, make sure it has put money in top notch securities as the company can default in paying interest, principal or both.