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Understanding risks in mutual fund

Understanding risks in mutual fund
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One of the reasons why a large number of people invest into mutual funds is to be able to bank on the professional abilities of seasoned fund managers. It makes their task of stock selection fairly easier. Nevertheless, there are certain risks involved in mutual fund investments too, and you must understand them well, as a good number of them are even beyond the reach of experienced fund managers. This is also the reason you see or hear those disclaimers in mutual fund advertisements – ‘Mutual Fund investments are subject to market risks, read all scheme related documents carefully.’

You may wonder, shouldn’t such risks be negligible as its professionals at the helm of affairs. Furthermore, shouldn’t these risks be lesser than compared to investing directly into corporate deposits and/or company stocks?

The investment instruments that mutual funds normally invest into are subject to periodic market movements. The price of debentures change based on the yields and papers available at a particular time, deposit rates get changed from time to time and the share prices change almost every minute. As a result, there’s no mutual fund which can 100% guarantee returns. There’s no one who can precisely predict the way the markets would move. So, it’s natural for equity mutual funds to lose their value with the plunging share prices; the corresponding mutual fund schemes are bound to suffer when the companies falter on their deposit payments.

Although professionals can reduce the stock-specific risks to a certain extent, there are many other risks associated with mutual funds that investors have to deal with nevertheless. Let’s go through some of these inherent risks as detailed below:

  • Interest rate risk 

This risk is applicable to debt mutual funds as returns from them can get inversely affected by the interest rate movements. So, falling interest rates may mean better returns and vice versa. The interest rates may get impacted by various factors like economic conditions, inflation rate, government borrowings and more.

  • Market risk

It’s no news that stock markets keep fluctuating from time to time. Hence, mutual funds’ net asset values may also get impacted by such market movements. As equity markets’ conditions are determined by political developments, economic conditions, interest rate changes etc., you can’t expect mutual funds to continue growing regardless of the underlying stocks. Long bearish runs may significantly impact your returns and you may get stuck with some schemes until the markets bounce back.

  • Reinvestment risk

This risk comes into picture during the times of falling interest rates. A debt fund manager may find it hard to get equally good rates after the maturity of certain papers or bonds in the portfolio. The same is applicable to the interest income earned from existing debt investments.

  • Liquidity risk 

The ability to dispose an instrument at a premium or existing market rate may get impacted during certain market conditions. If a security that the fund manager had invested in turns illiquid, the fund is bound to face losses overall. This could adversely impact the value of the scheme.

  • Credit risk 

The value and returns of a mutual fund scheme may also get jeopardized if it invests into commercial papers and corporate debt, and the corporate defaults on payments or fails to meet its contractual obligations.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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