Risks Associated with Mutual Funds:Mutual funds can be a great option to achieve long-term financial goals. It is especially suitable for those who do not know much about the stock market. It is managed by professional financial managers, who select suitable options for investment.
Mutual funds invest in different assets like stocks and bonds, thereby reducing the risk of your investment. Generally mutual funds are safe, but it is not correct to say that there is no risk in them. If you are thinking of investing money in any fund, then understand these risk factors related to it.
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Sharpe ratio: a simple way to risk
Sharpe ratio to know the risk of a fundThere is an easy way by which you can understand the risks associated with investment funds. With the help of this ratio you can compare different funds.In the Sharpe ratio, the risk-free return (which is obtained without taking any risk) is first subtracted from the fund’s return, and then divided by the standard deviation of returns (which reflects the fluctuations in returns). This tells you how well a fund has performed and how much risk it carries.
Standard Deviation: Measure of Volatility
Standard deviation is used to measure the volatility of a fund. Suppose, you have two funds:
Fund X: Average Annual Return 10%, Standard Deviation 2%
Fund Y: Average Annual Return 10%, Standard Deviation 5%
You have invested Rs 1 lakh in both the funds.
Fund X: Your investment may grow up to Rs 1.10 lakh, but due to standard deviation of 2%, your return may be between Rs 1.08 lakh to Rs 1.12 lakh.
Fund Y: Your investment can also grow up to Rs 1.10 lakh, but if the standard deviation is 5%, your return can be between Rs 1.05 lakh to Rs 1.15 lakh.
As you can see, Fund Y has greater volatility, which means your returns may be more uncertain. Therefore, it is important to keep the standard deviation in mind before investing.
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Beta: indicator of volatility
beta A measure that tells you how much a fund’s relative volatility is.
If beta is greater than 1, it means that the fund is more sensitive than the market.
If beta is less than 1, it means the fund is less sensitive than the market.
And if beta is at 1, it means that the fund moves with the market.
R-Square: accuracy of performance
R-squared Is used to measure the performance of the fund. This figure tells how much the fund’s performance is linked to the market. For example, if a fund’s R-squared is 0.8, it means that its performance correlates with the market with 80% accuracy.
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Apart from this, let us understand the risk types associated with investing in mutual funds.
Types of risks associated with investing in mutual funds
1. Market Risk
According to HDFC Bank, many external factors affect the market like natural disasters, recession, political changes, changes in interest rates, geopolitical situation and changes in policies. All these factors can affect the returns you get on your investment.
2. Concentration Risk
This happens when you put all your investments in one place. For example, if you invest all your money in a single sector (say Sector A) and that sector goes into recession, you may suffer huge losses. This risk can be reduced by investing in different sectors.
3. Interest Rate Risk
Debt mutual funds are more affected by fluctuations in interest rates than equity funds. When interest rates change, it impacts the debt instruments in your portfolio and also impacts returns.
4. Inflation Risk
High inflation reduces the real returns on your investments. For example, if you get 12% returns and the inflation rate is 6%, your real return is only 6%.
5. Liquidity Risk
Sometimes a mutual fund is not able to sell some of its securities. This causes loss to the plan, which directly affects your returns.
6. Credit Risk
This happens when the issuer of the bonds included in your mutual fund portfolio does not keep its promises. In this situation, the performance of the fund gets affected and your returns may also reduce.
How to reduce the risk of investing in mutual funds?
1. Diversification
Spread your investments across different sectors and different types of assets. With this you can avoid damage to any one area.
2. Take expert advice
Consult a SEBI-recognized financial advisor who can design a good portfolio as per your investment profile and financial goals. Do not take decisions without listening to anyone or on the advice of social media.
3. Switch Investments
When your investment goals are achieved, switch to safer options. For example, if you have received good returns, reduce equity exposure and invest in debt instruments.
Mutual fund investments are subject to market risks, but you can mitigate these with smart strategies and expert advice. Despite the risks, mutual funds are one of the safe investment instruments that give you good returns. So, don’t miss investing in mutual funds by being afraid of risks; These help you achieve your life and financial goals.
