What makes mutual fund an ideal investment option is its ability to help you achieve your financial goal through diversification.
Any financial goal such as retirement planning, your kid’s higher education, etc or anything that requires financial planning can be given a head start with the investment in a suitable mutual fund scheme.
To select a suitable mutual fund scheme you can either go to a financial advisor or you can learn about financial planning and wealth management.
All investments are subject to various kinds of risks and mutual funds are no exception.
So here we will quickly discuss the various factors that cater to the risk in mutual funds:
Increase in Rate of Inflation
The increase in inflation rate may lead to increase in the cost of living and hence this will reduce the real return in the hands of an investor.
The market volatility will always be a detrimental factor to the risk of capital being eroded.
If a portfolio is too concentrated on one sector, then under performance of that sector will deliver poor returns. The more diverse a portfolio, lesser would be the risk.
Rise in Interest Rates
A falling interest rate is positive for debt funds which are duration oriented.
Risk of Default
Some debt funds also invest in companies which assure to repay principal along with interest. Higher the interest is promised, higher is the risk involved when it comes to fulfilling its debt obligations
Despite the various risk involved in mutual funds, every mutual fund is not prone to every kind of risk. So for instance, fixed-income mutual fund schemes will protect you against the risk of rising interest rates.
Also, the equity mutual fund schemes will help you combat against the risk of rise in inflation rate.
Various mutual fund schemes are associated with various return percentages. It all depends on what returns do you expect as an investor and what is your risk appetite.
For instance a small cap fund takes higher risks compared to large cap funds. Hence it is expected that over a long period of time, the small cap fund would handsomely outperform the large cap fund.
A balanced fund contains equity as well as debt. So it is generally preferred by investors who are risk averse but want a return higher than 7-8%.
Now it is often assumed that higher risk means higher returns. However, one should always explore all the tentative possibilities of risk and return associated with a mutual fund scheme.
Also, one should not miss to check and compare the various types of mutual fund schemes based on its past performance.
The most detrimental factor in choosing a mutual fund scheme is the mutual fund manager because he/she is the one who puts in your money in a portfolio mix based on his expertise.
If the fund manager has selected his investments carefully, the fund should beat the market averages.
Also, if the fund manager engages fund towards a particular sector, the performance of the stocks in this particular sector will be the main driver.
For instance, energy funds do well when crude prices are rising, bond funds perform well when the interest rates decline and bond prices rise.
We all know and hear it often that “Mutual funds are subject to market risks, read all scheme related documents.” At least make sure to go through the Scheme Information Document (SID) in the offer document which will give you an insight about the asset allocation patter, scheme objective, scheme strategy etc.