What are the Risk Factors Mutual Funds?

Mutual funds allow investors to pool their money to invest in a diversified portfolio of stocks, bonds, and other securities. While this diversification makes mutual funds a reliable way to grow wealth, they do carry certain risks that can affect your returns.

Knowing the various risks you are exposed to while investing in a mutual fund is important to avoid incurring significant losses in the investment. This article explores these risks in detail and how they can affect your investments.

What are market risks in mutual funds?

Market risks in mutual funds arise from the fact that they invest in various investment instruments – equity, debt, corporate bonds, and so on. When the prices of these investments fluctuate, it might lead to risks in the mutual funds.

However, by identifying risks associated with mutual funds, you can make the most of the risk-reward feature of mutual funds to maximise your returns while minimising the rewards.

Type of risk factors in mutual funds

Equity fund risks

1. Volatility risk- Equity funds generally invest in company shares listed on the stock exchange. The value of these funds depends on the performance of the company, which is affected by various socioeconomic factors. Any change in the company's performance affects the share price.

2. Liquidity risk- Liquidity risks indicate the inability to sell or redeem the equity funds at the desired price. Long-term funds or funds with a lock-in period, such as ELSS, often carry this risk.

Debt mutual fund risks

3. Credit risk – Credit risks arise when the scheme issuer fails to pay the interest or principal on the investment. Mutual funds investing in low-rated or unrated securities are highly vulnerable to credit risks. It can lead to loss of income or capital for the investor.

4. Inflation risk - When the return on your mutual fund is less than the rate of inflation, you are exposed to inflation risk. Debt mutual funds offer fixed returns that might not beat inflation. This reduces your money's purchasing power and reduces the real value of investment.

5. Interest risk- Debt funds invest in fixed-income securities like debentures and bonds. Any change in the market interest rates affects the price of these securities. This can lead to interest risk for the investor.

6. Concentration risk – Concentration risk can arise if investors put all of their money into one scheme or sector. This can make the mutual fund more vulnerable to risks affecting such specific sectors.

7. Currency risk - If the equity fund invests in any foreign assets, fluctuations in exchange rates may have an impact on your returns when exchanged for Indian rupees.

Conclusion

Mutual funds are excellent investment tools that offer you the opportunity to invest in a variety of securities and generate great returns in the long term. However, before investing, it is critical to know and understand the various market-related risks, interest rate risks, credit, or liquidity risks associated with mutual funds to ensure the safety of your investment.