Haven’t we all memorized the ad saying, “Mutual Fund Schemes are subject to market risks. Read all scheme-related documents clearly” with no fault of our own?
As you read this, the voice echoes in your head! (I hope it did.)
Your wonderment regarding the risks prevailing in the mutual funds market is understandable. Also, curiosity drives knowledge.
Though investments are made to channel our savings, it feels unhealthy when the same savings are drained due to risk and uncertainty.
It is obvious to wonder, why do people take this risk?
Well, while debt and other secure investments may offer a promising return, they are not ample to fight inflation and additional costs.
Hence, investors find it extremely healthy to take a calculated risk and fund their savings into investment schemes that may yield high returns.
What are Mutual Funds?
In simple words, a mutual fund is an investment vehicle where investors pool their resources. It is further invested in various securities like stocks, bonds, money market instruments, and assets.
Basically, an investor’s money is allocated to multiple securities after a mutual agreement between the concerned authorities.
Mutual funds are driven by money managers who allocate the funds into potential securities in an attempt to achieve gains.
So, where exactly is the risk?
The risk factor is that mutual funds are known for asset allocation, which implies that they allocate your money in various securities listed above.
Moreover, price and risk factor involved in every such security keep changing concerning the dynamic business environment. The market’s volatility is responsible for the fluctuation in the Net Asset Value of a person.
Net Asset Value is the current value of investments made by the person with the Mutual Fund Agency.
The risk involved in mutual funds schemes can be broadly classified under the nature of investment they are related to:
Risks involved with Equity Mutual Funds:
Equity Funds are related to investments made in shares of listed companies. The value of the asset depends on the performance of the company.
The risk of volatility comes in because of the level of uncertainty involved in such securities. Every micro and macroeconomic factor can shake the firm’s performance and potential in an unknown direction.
It is referred to as the risk involved in the redemption of an investment. Due to their restrictions, funds that have a long-term lock-in period come with liquidity risk.
Investors find it difficult to sell off their investments without facing a loss. They are not much in demand, and therefore there is a lack of investors for such investments.
Risks involved with Debt Mutual Funds:
If the interest rate of a bond decreases, the demand and further the value of the bond also decreases.
Interest Risk is a factor arising because of the interest rate that debt carries. It is likely to haunt the investor at the end of the span of the debt.
This is the most prevalent and concerning risk in the case of debts. When it comes to investments, the solvency of the issuer is of utmost priority.
It arises when the issuer of the security fails to pay the interest. That is why credit rating is considered essential when an investor scrutinizes a debt mutual fund.
Money managers generally include lower credit-rated securities to enhance the rate of returns. This increases the credit risk involved in the security.
It is the risk of losing the value of money. As you know, risk and rate of return move in opposite directions.
Less risk implies a low rate of return and a higher risk may or may not promise a high rate of return.
Debt security offers safety, which is why the rate of return is lower. If we analyze this situation, it simply means that your money will lose its value over time.
Though it will stay intact in quantity, you are vulnerable to losing your purchasing power.
Some Other General Risks
Amateur investors tend to put all their money in one single security or an individual sector based on higher promising returns or better protection.
It exposes the investor to greater risk because all his money is held by a single company. Therefore, asset allocation is a better choice.
If you distribute your investments, and 2 of the companies you invested in dissolved, at least the rest of the investments would remain safe. This is the benefit of asset allocation.
This risk exists due to fluctuations in the exchange rate. When the value of foreign currency-dominated funds increases, the consequences are likely to be a drop in foreign currency value.
It will negatively impact the value of return when converted into INR. A decrease in the exchange rate would degrade the investment returns.
Money managers regularly rebalance your investments to achieve maximum gains. Regular reinvestments are made on the cost of growth opportunities.
Hence, to minimize your rebalancing risk, one must plan their investments smartly.
This is a general factor that affects the securities market as a whole and is unavoidable. It impacts the performance of the market.
A few reasons can be natural disasters, political unrest, pandemics, among others.
What are the alternatives to Mutual Funds?
Mutual Funds are not the only option to combat inflation via savings. Investment also envelopes various sectors like Real Estate, Scientific Research, and Mining of precious stones.
Let us talk about all the alternatives.
Investors consider them the safest and most stable investment options. Fixed Deposits are time-specific deposits and one can liquidate them only after the timespan is over.
Such deposits guarantee hassle-free fixed interest. However, their only drawback is the ability to combat inflation.
Some of the FDs also promise the benefit of compounding for long-term investments. They are a healthy option if you do not have an appetite for risk at all.
It is a brilliant option for long-term investment and ascertains promising returns. It puts forth direct ownership of a company regarding voting rights and percentage ownership.
One also acquires a piece of dividend on the percentage of shares held. Before investing in direct equity, it is advisable to research the company’s growth prospects, vision, framework, and past performance.
Post Office Saving Scheme
The government introduced this scheme to instill the habit of saving and investment in people.
The scheme has witnessed ever-increasing participation and is significantly safe. It is easy to enroll and one of the best investment options available.
There are multiple accounts available according to your eligibility. The most common and popular ones are:
- Post Office Savings Account
- Post Office Time Deposit Account (TD)
- 5-year Recurring Deposit Account (RD)
- Monthly Income Scheme Account (MIS)
Bonds are fixed-interest investments. They are similar to loans and advances. However, you can transfer, buy, and sell a bond in an open market.
Ascertain healthy terms when you are investing in bonds. One must thoroughly read the terms and conditions mentioned before purchasing or investing in a particular bond.
The price and interest offered on a bond are inversely related. Government bonds are, however, safe and more liquid.
National Pension Scheme
Run by the Government of India, NPS is a scheme that encourages securing a citizen’s finances after retirement. It has no risks involved.
It exposes you to the opportunity of investing in government equities, bonds, and debts as per your preference for the long term.
NPS is a sound and safe investment option and yields great returns. Also, it is a method to avail tax benefits under Deductions from Chapter VI-A.
Public Provident Funds
A PPF is a very healthy and rewarding investment plan. It aims to encourage investments to inject the economy with money. Like the NPS scheme, PPF also enjoys government backing.
Public Provident Funds offer a maturity period of 15 years, although one can withdraw partially after 6 years of investment.
It puts forth amazing opportunities besides the interest. You can avail deductions under section 80C for your Income Tax.
You can also use PPF Accounts as security for availing loans.
If you have to invest a huge amount, I recommend going for a long-term investment in real estate.
Real Estate investments returns can be classified as rent and sale price. They are highly rewarding and also assist in establishing an asset.
Investing in real estate requires a good knowledge of land-development plans and construction contracts.
It also helps you avail tax benefits under income from house property.
Certificate of Deposit
Certificate of Deposits are fixed-income investments in the form of loans and advances. Their goal is to lend money to the bank for a certain span.
The minimum time scheme is 3 months, and the maximum extends up to 10 years. An investor tends to receive a higher interest rate for a longer locked time.
Investment does not confine its benefits to just the investors. Its benefits extend across the ecosystem. There is a reason why investments are termed injections, and savings are known as leakages for the economy.
Keeping your money aside harms the financial structure, brings inflation, and degrades your purchasing power. On the other hand, investment schemes channelize your idle money into better uses that drive you a passive source of income.