You may choose amongst several types of mutual funds such as equity, debt, and balanced funds. Each of these fund options has a certain level of risk based on multiple factors. You must choose the funds based on your risk appetite, liquidity requirement, and investment horizon.
Here are some risks that are associated with mutual fund investments.
- Price risk
Every advertisement for mutual fund investments shows the caveat that such investments are subject to market risks. This means that in case of adverse market conditions, you may actually see a reduction in the value of your capital investment.
However, when you invest in SIP (systematic investment plans); the risks are associated with the investment horizon. Therefore, you are able to reduce the risk by remaining invested for a longer period of time. A longer investment horizon increases the possibility of earning higher returns.
- Liquidity risk
The liquidity of your capital depends on the underlying investment. Although this is not often true when you invest in mutual funds. However, during certain periods like in 2008, there were some issues in exiting your investments in bonds. Moreover, some limitations were also levied on certain mutual fund schemes.
Investing in equities is highly liquid because buying and selling on the stock market is easy. However, if the sale quantities are more than the buying quantities, there may be certain liquidity risk.
- Credit risk
If the credit companies downgrade a particular investment, generally its price decreases. The price decrease negatively reduces the value of your portfolio. This is referred to as credit risk. You may mitigate credit risk by choosing to invest in schemes that have a higher rating.
- Fund management risk
Every mutual fund scheme is managed by a professional manager. You expect a certain return on your SIP investment. However, the fund may not perform as per your expectations and your returns may be negatively impacted. The fund manager may not deliver as per the expectations thereby resulting in lower returns on your investments.
- Technology risk
Today, technology is widely used when you invest in any investment product. Most transactions are electronically executed posing the risk of entering incorrect information. There is also the risk of the SIP transaction not being processed, which is another kind of technology risk.
- Default risk
Debt mutual funds invest in various types of bonds and securities. However, there is a certain default risk wherein the issuer does not make timely payments on the bonds. As a result, your portfolio returns are negatively impacted.
Investing has several risks as discussed above. However, you need to remember that the SIPs are only investment vehicles and not the underlying. Therefore, you must evaluate the inherent risks of the underlying to make an informed investment decision.