An investment that can yield high return at minimum risk is a prudent way to generate wealth for achieving financial goals. While there’s no denying that mutual fund investments can help you fulfil your short- and long-term financial goals, the risks associated with the same shouldn’t be overlooked. Being aware of the potential risks will help you review your investment portfolio in a much better way. Ahead, we are going to shed some light upon some of the common investment risks involved in mutual funds. Read on to learn about the same:
Risks affecting mutual funds
- Market risk
With mutual funds, you can invest in a variety of financial instruments such as equities, gold and debt securities like corporate bonds, government securities etc. The value of these instruments keeps on fluctuating due to various reasons. As of result of the market volatility, there is always a likelihood that the mutual funds you hold might be caught in a decline. Therefore, it becomes essential that you evaluate your risk appetite beforehand and invest in mutual funds accordingly.
- Inflation risk
Rising inflation rate is yet another factor that can affect your mutual fund returns. You will have to bear the impact of this risk when your investment returns fail to keep up with the increasing inflation rate. For example, if your mutual fund return is 5% and the rate of inflation is 3%, you will be left with an actual return of only 2%.
- Credit risk
Credit risk in mutual funds investment results when the issuer of the bond or other security fails to pay the promised interest. When it comes to credit risk, funds that invest in government bonds are considered to be the safest. However, securities that have a higher risk of default tend to pay higher interest.
- Liquidity risk
Liquidity risk refers to the risk of incurring a loss while redeeming the investment. In mutual funds like ELSS, the rigid lock-in period may result in liquidity risk. The ideal way to minimize the liquidity risk is by having a diverse portfolio and choosing your funds carefully.
- Interest rate risk
Interest risk in mutual funds refers to the risk of varying interest rate throughout the investment horizon. The interest rate may change on the basis of the credit available with lenders and the demand from borrowers. It is to be noted that a rise in interest rate may cause your mutual fund value to decline.
You must make a note of all the above-mentioned risks involved in mutual funds and create a balanced investment portfolio for yourself. Do not forget to evaluate your financial position, age, income, and future goals while making a mutual fund investment. If you have a low risk appetite and want to stay invested for long-term, a balanced portfolio with a profitable mix of both debt and equity funds would be suitable for you. Research the market carefully before investing in mutual funds. Lastly, do not hesitate in seeking the help of a mutual fund advisor to make a well-informed decision.