What does ‘Mutual Fund is subjected to market risk' really mean? |
Posted: June 21, 2018 |
'Mutual Fund Sahi Hai’ campaign has been very successful in attracting people to buy Mutual Funds. However, it can mislead people into thinking that it is safe, that there are actually no risks in Mutual Funds. It has the power to lull people into ignoring the statutory warning, ‘Mutual Funds are subjected to market risk….’, Just like cigarette smokers ignore the warning which is so much more threatening and conclusive, ‘Smoking Kills!’ While it’s true that Mutual Funds in India can be a good investment option, you shouldn’t forget that they have an inherent market risks associated with them. Risks are inevitable in stock investing, because we are dealing with future, and the future is uncertain. Understanding risks helps you take actions to control and manage them. And, then you expect returns that do justice to the risks you have taken. What are the risks in Equity Mutual Funds?1. Volatility Risk:Volatility means that it can change rapidly and unpredictably e.g. stock prices. As Equity Mutual Funds are invested in portfolio of stocks, their NAV-value/prices are also volatile. Despite knowing this, different investors react to volatility differently, and that is what causes a bigger damage. It has been found in a study that, an average Mutual Fund investor doesn’t hold an MF beyond 24 months. Investors with lower risk appetite, as MF investors tend to be, sell when the value of his investment goes down. This leads to permanent loss of capital or not enjoying the full benefit of having invested in right assets. Staying invested in the market for a longer period is the best solution to fighting volatility risks. And, ensuring your portfolio does not have a significant Downside at any point of time significantly increases the chances of you staying invested. A portfolio of Equity and Debt Funds has lower volatility. Also, Smart Asset Allocation – moving the ratio in favour of Debt, when the markets rise irrationally, also reduces the downside risk. SIP in MFs has proven to be a popular solution to prevent investors from reacting counter-productively to volatility. It predisposes the investor to invest, and therefore, to hold his/her earlier investments in a Mutual Fund through ups and downs. In all these, it is critical that you invest in the right Mutual Funds, because time won’t reduce all risks e.g. Fund Manager Risks. 2. Fund Manager Risk:Not many Mutual Funds in the past have consistently performed, irrespective of the market scenario. There’s always a risk that a Fund Manager may underperform during some years, as all the investment strategies (Value Investing, Growth Investing etc.) don’t work for all times. How a Fund Manager reacts to periods of under-performance is more important. The risks are higher, when a Fund Manager does not stick to process-driven investing. It may happen due to the pressure to generate returns more than Benchmark Index in the short run…perhaps also intensified by his incentives and career aspirations. This approach clashes with the investors’ goal i.e. ‘to generate wealth in a sustainable manner over long run.’ This misalignment can be eliminated only by exiting a Fund. The other source of risk here is the exit of a performing Fund Manager. The lack of track record of the new Fund Manager adds to the uncertainty and risks Continue Reading here...
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