The risk aspect of mutual fund investing has long been a topic of conversation. While being the go-to choice for most financially savvy individuals, mutual funds are still market-linked and thus a question frequently arises – ‘Is mutual fund safe?’
We’ll address this question by walking you through the various aspects of mutual funds, including the risks associated with it so that you can learn more about the degree of safety involved in mutual fund investing.
What are Mutual Funds?
A mutual fund is an investment vehicle that pools money from hundreds or thousands of individual investors.
This combined capital is then used to acquire a portfolio of stocks, bonds, and other securities by fund managers.
Fund managers are professional portfolio managers who make investments on behalf of the participating investors.
Investors can invest in these funds on a lump sum as well as via a Systematic Investment Plan (SIP).
The SIP route makes this instrument affordable for many as the minimum investment can be as low as Rs. 500.
Mutual funds serve as a straightforward yet affordable solution for investors to have access to a variety of assets.
Why Do People Invest in Mutual Funds?
Investing in mutual funds offers many benefits, the primary one being diversification.
Mutual funds spread investments across a range of securities, reducing the impact of underperformance in any single asset.
Mutual funds are managed by professional investment managers who lead analysis-based investment decisions, resulting in higher returns than individual investors. Then there’s the choice between Direct and Regular Mutual Funds.
Moreover, investors can buy or sell mutual funds based on their convenience and most mutual funds are know to be fairly liquid (if open-ended funds).
Also, investors from different risk profiles can invest in mutual funds based on the constituted portfolio.
For example, investors with higher risk appetite can invest in thematic and equity funds, while investors with low risk can invest in liquid or bond funds. That said, there is always a degree of risk involved.
Risk Factors in Mutual Funds
Mutual funds provide numerous benefits, but there are no benefits without a certain degree of risk.
When assessing the reliability of mutual funds, it is important to understand these risks, and then act accordingly.
1. Market Risk
Mutual funds are intrinsically susceptible to market risks, which means their value might fluctuate with the volatility in the stock and bond market.
If either the market or individual components within them fall, this can impact the portfolio value of mutual funds, causing loss to investors.
Investing in a well-diversified mutual fund and holding other mutual funds that counter this risk, for example – debt funds, are some of the ways in which investors manage market risk.
2. Liquidity Risk
This depends on the type of mutual fund chosen such as close-ended funds. These funds cannot be redeemed before maturity and can be an issue for investors in times of emergency.
The counter to this lies in capital allocation and always having an emergency fund that gives you access to quick cash.
3. Interest Rate Risk
Fixed-income securities are subject to interest rate risks. The value of existing bonds is known to decline with the rise in interest rates, lowering the net asset value of the fund.
Most savvy investors are known to counterbalance interest rate risks by investing in high-quality equity funds. However, you must know that this is diversification across asset classes, not within.
4. Marginal Diversification
Despite diversification being commonly mentioned as a benefit, diversity cannot eliminate all risks.
Even well-diversified portfolios can incur losses in stormy markets if diversification is limited to the equity market only.
For example, an equity fund. While it invests in different stocks, it is still categorized as equity investment and market changes can impact the fund. What to do in such a situation? Invest in only the best.
Is It Safe to Invest in Mutual Funds?
The safety of investing in funds hinges upon an investor’s risk tolerance and financial objectives. However, many prospective investors may wonder, “how safe is mutual fund?”
Compared to direct equity investments like stocks, mutual funds are known to be less risky, especially over the long term. However, you must pick the best mutual funds for your financial needs.
You can do regular monitoring and periodic assessments of your mutual fund portfolio to ensure that your investment reflects your objectives.
If you are wondering ‘Is mutual fund safe?’, then the answer is that mutual fund investments are generally considered safe for long-term investors.
Mutual funds investment involves diversification of funds and portfolio management to make decisions.
Investment always carries risks. However, you can lower the risks involved by taking a well-informed approach and improving your chances of success.