Sep 15, 2017 4 min read

Investing in Mutual Funds? Know the Inherent risks and their solutions

Do you know the inherent risks of mutual funds? Know here with the best solutions.
The risk is everywhere, small or big, we all confront it in the work of our everyday life. Some risks in life are inherent which cannot be mitigated, and some possibly can be reduced to the minimum. Knowingly or unknowingly, we all do take the risk. Little risk offers less opportunities while the bigger challenges open up the doors to attain greater success.

There are live examples too, which reflects the idea of ‘big risk, big achievements.’ The billionaire businessmen who take high risk and establish the large business could be the best example of this. The only difference between the two contradictory nature of the people regarding risk taking is that the extraordinary one takes thoughtful, calculated, and visionary risk, whereas the ordinary one takes the unthoughtful and unprejudiced risk which is more harmful.

There are risks involved in investing too. You must have often heard that mutual funds are the safest among the investments when you want to earn significant returns from equities along with minimised risk. But, you might not be aware of the inherent risks of mutual funds. There is certain threat to your hard-earned money even when you are deploying them in mutual funds. We will tell you the detail about those vital risks and also the solutions to avoid them.

The Inherent Risks of Mutual Fund with the Solution to Minimise them:

1.Credit Risk : Debt mutual funds are prone to credit risk because they invest in various commercial papers, bonds, debt instruments, etc. Suppose you have lent some money to your friend, there are possibilities that he defaults. Similarly, the corporates in which the debt mutual funds invest the capital may also fail to meet the contractual obligations.

Solution : However, it is impossible to mitigate the inherent risks, but one can reduce it down to the minimum by putting little more efforts in the selection process. We suggest analysing the credit worthiness of the debt instruments in which your fund is investing the capital. Select the one with the higher grade to lower down the maximum possible risk. Several bonds hold credit rating like AA, AAA, SOV, etc., which describes their credibility. The government bonds never default and are the safest one to invest in.

2.Interest Rate Risk: Many investors are unaware that the prices of the bonds rise when the interest rate falls as they both are inversely related to each other. So, when the rate of interests is going dearer, you do not get any chance to reap benefits. Therefore, it gets critical for the investors to gain profits from the investment in debt securities.

Solution : You can be on the positive side of returns if you take a round-up of the interest rate cycle in the economy before investing in any bonds. Further, go for investments if the scenario seems to be in favor or wait for the better time in the future. To stay invested for a long tenure is one more panacea to reap the best profits out of your debt investments.

3.Price Risk : Equity fund is the category which is known for providing double-digit returns. But, the investment in them also consists of certain permanent risk. Price-risk dominantly affects the growth and returns from the equities. If the market price is moving southward, the NAV of your fund also moves in the same direction. In the short-term duration, the markets remain highly volatile which is a threat to the profitability.

Solution : Although, the short-term price fluctuation may threaten the profitability of your funds but in the long tenure the risk gets averaged. If you stay invested in the equity funds for the long-term period, the price-risk factor will automatically be reduced to the minimum.

4.Economic Risk : Your mutual fund investments also get affected by the behavior of the overall economy. The economic factors like inflation, crisis, interest rates, growth, etc., have their significant impact on the performance of your fund. If the overall economic condition is in good shape, then your investments will also perform in the upward swing and vice versa. The risk of the economic crisis cannot be neglected, nor it can be mitigated. If in any phase the economy goes through a bad track, it drastically affects the investments as well as the financial stability of the people.

Solution : We can never ignore the destiny, but we try our best to stay well and secured. Also in the mutual funds, if you invest in the scheme which has showcased a consistent performance, it helps to safeguard your capital from the effects of economic risk to the maximum possible extent. So, be cautious while choosing the funds.

Henceforth, you can lessen down the various risks which are inherent in mutual fund investments but can never mitigate them. The best step you can take is to choose the most appropriate plan considering all other factors. To know about how to choose the most suitable funds for you, read our blogs at MySIPonline and start making your dreams a reality.