Investing in mutual funds is one of the most popular ways of investing money today. These funds pool the money of many investors and use it to purchase a diversified portfolio of securities, such as stocks, bonds, and other assets. As with any investment, there is always some risk involved. However, mutual funds offer an advantage over other investments because they are professionally managed by experts who have extensive knowledge of the markets and how to maximize returns on investments. That being said, below are two main types of risks that mutual funds carry.
Market risk
Mutual funds are widely invested in stocks, which carry market risk. The unpredictability that comes with making any kind of financial decision is referred to as market risk, which is also sometimes called systematic risk. Price volatility is frequently the result of unexpected shifts in elements that routinely have an effect on the entire financial market.
Systematic risk is not directly linked to the company or the sector; rather, it is contingent on the success of the market as a whole. As a result, it is essential to maintain a close watch on the many macro variables that are associated with the financial market. Some examples of these variables include inflation, interest rates, the state of the balance of payments, fiscal deficits, geopolitical factors, and so on.
The risk can’t be diversified away in order to reduce its impact on the market as a whole, but it can be hedged in order to reduce the amount of exposure it causes. As a consequence of this, you might not earn the returns you had anticipated despite the careful application of fundamental and technical analysis to the specific investment option in question.
Interest rate risk
Bonds and similar debt instruments that mutual funds invest in come with interest rate risk. The unanticipated movement of interest rates as a direct result of actions performed by the Reserve Bank of India in the realm of monetary policy is the source of the risk associated with interest rates. In the long run, the yields that are given on securities on all markets will need to become equivalent. This can be accomplished by adjusting the demand and supply of the instrument on the market. As a result, there would be a decrease in the price of the security if the rates were raised. It is most commonly connected with securities that have a fixed income.
Take, for example, the case of a sovereign bond that provides a set coupon payment of 6% per annum on the principal value of the bond. Now, if the market interest rate were to rise to 8%, demand for the 6% bond would decrease, which would result in a fall in prices. This would cause the yield to rise until it was equal to 8%. In a similar manner, a drop in the interest rate of the market will result in an increase in the price of the security that was not anticipated.
Conclusion
Investing in mutual funds carries certain risks, such as market risk and interest rate risk. However, these risks can be managed by professional fund managers who have extensive knowledge of the markets and how to maximize returns on investments. It’s important to keep in mind that investing in mutual funds is not without risk, but it can be a good option for those who want to diversify their portfolio and gain access to professional management. It’s important to consider your risk appetite and investment goals before investing in mutual funds or any other investment option.