Do you think driving a car or using an electrical appliance at home entails risk? There is enough data available about accidents caused by these and loss of life and property. But this does not mean you will not drive a car or use an electrical appliance. We do not consider them to be risky since we know how to use them. Most accidents take place out of human negligence. Mutual fund investments are no different. Understanding an investment vehicle (mutual fund) and the risk-reward associated with it can help you handle risk better. It is no wonder ace and veteran investment guru Warren Buffett once said, “Risk comes from not knowing what you’re doing.”
Mutual funds are vehicles that pool investors’ money and invest in line with the stated investment objective of the scheme. Each mutual fund has a stated asset allocation which details where investments will be made and how risky they are. The stock market regulator Securities Exchange Board of India (SEBI) has made mutual fund houses to clearly state the risks involved in each of the mutual fund scheme by giving risk-o-meter ratings. It ranges from low risk to very high risks. SEBI keeps issuing various risk management tools for mutual funds to ensure that risk taken is contained and interest of investors and mutual fund companies remained aligned with each other.
Here are a few things you should know about mutual funds in the context of risk:
Safety
Safety of capital is an important factor in all investments. Though stocks are volatile in nature in the short-term, they tend do well in the long-term. The only way to contain downside in stocks is to diversify and stay invested for the long-term. Mutual funds offer you diversified equity portfolios, which are relatively less riskier than investing in a stock or an arbitrarily constructed concentrated portfolios. Mutual funds also offer diversified bond portfolios in bond schemes where safety of capital is given importance.
Returns
Earning superior returns is everybody’s dream. But earning it consistently is more important. Avoiding large losses ensure that your portfolio gets sustainable returns. Mutual funds’ diversified portfolios and risk management techniques ensure that investors get healthy risk adjusted returns.
Liquidity
Though safety and returns are two sides of the same coin and always keep ruling the mind of a risk conscious investor, the liquidity element cannot be ignored. Many a time investors buy a stock or a bond in search of returns. But if they have to raise money to meet some cashflow requirement, then they find it difficult to sell their investment. Mutual funds address this issue. There is assured liquidity at the net asset value of the unit of the mutual fund schemes.
Informed investing
Mutual funds employ a set of professionals who have necessary skill-sets such as investing, analyzing, managing risk, managing investment operations among others to make sound investment decisions. This ensures that there are experts at work to take care of your money. This in turn reduces your cost of investments.
Hence, mutual funds is one of the easiest and relatively safest ways of investing your hard-earned money in markets. No wonder, mutual funds are seeing increasing inflows in the past two years.
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