While it is true that the act of investment can help you with the long-term acquisition of wealth. It is important that you need to determine your investment objective and more importantly, you should not rush into investing blindly. This is especially applicable to an investment in mutual funds. Mutual fund schemes are already known for coming with a lot of risks already and you don’t want to add the additional risk of investing without a specific goal in mind. But before learning about the risks associated with them, first look at what mutual funds are and how they work.
What are mutual fund schemes?
In simple terms, mutual fund plans can be defined as investment tools that are known for pooling money from different investors to purchase different financial securities. Once enough money is accumulated in the fund, it is used to invest in various financial securities like gold, stocks, and money market instruments. By opting to buy a unit in a mutual fund scheme, you get to own a small stake in all the investments that are regarded as a part of the fund. Due to the numerous benefits associated with them, mutual fund schemes are considered a smart investment choice by financial experts.
How do they work?
To sign up for a mutual fund scheme, you first need to approach an AMC i.e., asset management company. These firms are known for offering mutual fund schemes and their different variants. These schemes are known for coming up with a specific investment objective that caters to the distinct investment needs of different investors. Depending on the objective of the fund, the money accumulated in the pooled fund is allocated to different securities such as gold, stocks, bonds, and other money market instruments. The professional referred to as a fund manager is responsible for overseeing each fund. The fund manager has one goal. It is to earn optimum returns on the fund’s investments. Then, the income generated by the fund is divided and distributed among the investors proportionately.
What are the risks that are associated with mutual funds?
While it is true that they come with a lot of benefits, it does not mean that these schemes are risk averse. In reality, to invest in these funds, you need to have some risk appetite. It is only by taking risks that you can earn through mutual fund investments. However, the risks that help you in earning revenue are calculated ones. You can’t expect to earn anything by taking risks blindly in mutual fund investments. Here are some of the risks associated with mutual fund schemes:
- Market Risk:
Market risks can be defined as losses because of the poor performance of the market. Inflation, natural disasters, political unrest, recession, and many more are some of the factors that are known for usually affecting the market. Also referred to as systematic risk, even diversifying your portfolio won’t help in these scenarios. The only thing you can do is wait for things to get better and that might take time. The COVID-19 pandemic is the best example of this.
- Concentration Risk:
In the world of investment, concentration risk means that you have invested all of your money just in one asset class. Investing a considerable amount of your funds into one particular asset class is never a good option. This action will be fruitful only if you are lucky and the particular asset class is presently performing well. If not, you will be losing your money. The best way for minimising this risk is by diversifying your investments. The more diverse the portfolio, the lesser the risk for your portfolio.
- Liquidity Risk:
This type of risk can be defined as the difficulties you may face while redeeming an investment without incurring a loss in the value of the portfolio. A liquidity risk might also occur whenever a seller can’t find a buyer for the security in their possession. For instance, in mutual fund variants, like ELSS, the lock-in period might result in liquidity risk because no redemption can be done during the lock-in period of three years.
Is it possible to lose more than you already invested in mutual fund schemes?
The profits and losses in mutual funds are dependent on the performance of stock and financial markets. So, by opting to sign up for mutual fund schemes, there will be no guarantee you will not lose money. In certain extreme circumstances, it is also possible that you could end up losing all your investment options. So, one of the things that you can do is have a longer investment horizon in mind. That’s because, if you are investing for achieving wealth in the long term, the chances of losing all of your investments may remain low. Even when the market was to be at an all-time low, if you were to continue paying for mutual funds investments, you may end up acquiring enough wealth whenever the market recovers.