Thinking of starting an investment, then you must know the term ‘risk’ associated with investment. ‘Risk’ and ‘Mutual Fund Investments’ are like two parallel lines of railway track, that run along with each other, and you can’t think of one without other. It is said that in Mutual Fund Investment, “higher the risk, higher the gain, and lower the risk, lower the gain”.
Before you start investing, through this blog you must learn about the factors affecting the risk in mutual fund investments and kind of risk in Mutual Fund Investment, also get to know, how you can convert risk in your investment in profit gaining factor.
Risk in Mutual Fund investment depends on what type of stock or bond, capital is invested in. We already know that when an investor invests money in mutual fund through Mutual Fund Company (Asset Management Company), which in return invests these sums of money in purchasing units of assets like corporate bonds, equities, government securities and many more. The market value of these assets generates returns on investors' investment. The market price or value of these assets is affected by many factors like the demand of these assets in the market, supply according to the demand, inflation, etc. These factors readily alter the selling price of the assets and do alter the returns in investments.
Let’s get clear through an example. Rima, an engineer invested in mutual funds through an AMC (Asset Management Company), which in return invested her money on units of an XYZ company’s shares. After five years, the XYZ company faces a loss and the market value of its shares goes down, leading to low returns on the investment. With the same Rima receives a low return on her investment. The utmost thing here that matters is, the market value of XYZ company's share has gone low but has not collapsed. It can also go up when the company gains profit, thus can lead to good returns on investment. At this stage, Rima, being a smart investor, didn't get nervous and maintained her patience. As a result, in the five years, the XYZ company received a huge profit and the market value of its shares went up, generating a good return on investment, and thus Rima when withdrawing her investment at this stage, she received a good return on her investment.
In this way, Rima wisely converted her risk of loss in profit-generating factor through long term investment.
Risk in Mutual fund doesn't take the investors on the way of loss. Risk in Mutual Funds is beneficial which results in generating good yield in returns on investment.
As of now you are aware of the factors of Risk in Mutual Fund Investment. You also need to learn about the kind of Risk in Mutual Fund Investment. Kinds of Risk in Mutual Fund Investment are:
- Concentration Risk: Teachers and parents generally say that concentrate on a single goal of your life only then you will be benefitted, but this is not true in the case of Mutual Fund Investment. Investors who concentrate on a particular Mutual Fund Scheme and invests all his capital in the same, they will receive a good amount of return if the value of the assets goes up, but conditions will turn upside down if the value of the assets goes low in the market. Here the subject arises of luck, if you are lucky, good for you, if not then conditions will be worse for you. To hinder this risk, Investors are always suggested to diversify their portfolios, because the more diverse your portfolio will be, the less risk of loss will be.
- Urgency Risk: Sometimes, the investor faces some drastic situation in life and at the same time run out of money and is abandoned helpless. Generally, in this situation, they decide to sell their unit of an asset in the market but faces a lack of good selling price from the buyer due to the low market value of the asset. This situation often refers to Urgency Risk. The best remedy to resist this kind of risk is diversifying your investment portfolio. For example, Samar, an engineer has invested in three different mutual fund schemes. Recently he lost his job and is in search of a job, but on an urgent basis, he requires 5 lakh rupees for his son's admission to MBA college. He decides to sell his unit of the asset purchased through the first mutual fund scheme. Due to its low market value, he is unable to get good price from the buyer for his unit of asset. Instead, he is getting low price for his unit of asset. But thanks to his diversifying portfolio, he still has two other mutual fund schemes in his hand through which he can arrange the amount of money he requires.
- Liquidity Risk: Liquidity in Mutual Fund is defined as how easily any unit of an asset can be bought or can be sold, in simple words, how easily unit of assets in a mutual fund can be converted into cash. It is followed by two types of risk, first Funding Liquidity Risk, and second Market liquidity Risk. Funding Liquidity Risk basically refers to the risk of a company or firm, whether it can fund its liabilities. It can be calculated easily, by dividing the company’s current assets by current liabilities. Market Liquidity risk is the inability of an investor to easily sell or buy a unit of asset.
- Market Risk: The value or performance of the market is not consistent. Sometimes its value reaches beyond the limit of the sky and sometimes its value touches the core of the earth. But the best part is it doesn't collapse. The ups and down performance of market readily affects the market value of assets. When the market value goes low, investors need to take a deep breath and wait for the thunder to stop. After that, the sky will be full of clouds of rain or here we can say, when the market value will go up, it will surely generate good returns on investment.
- Interest Rate Risk: This is normally a temporary kind of risk, which happens due to fluctuations in the interest rates in the market. For example, a fund lends money to ABC Ltd. @ interest rate of 8% p.a. Due to the change in the market scenario of interest rates may change for the same company. If the interest rate goes down, the current mark to market of the such lended money will increase and vice versa. Hence these risks may create short-term volatility in the market value of Debt papers. Though these risks are destined to be nullified by the maturity date of such loans. They may be permanent in nature due to various reasons.
- Credit Risk: The borrower may not be able to pay the amount on a promised date. Sometimes, the borrowers without returning the money vanish from their place and make a credit loss on the lender. In Mutual Fund Investment, when the investor isn't paid the promised amount by the issuer of the mutual fund scheme, then this situation is referred to as credit risk.
As of now, you have understood the kind of risk an investor is likely to face in Mutual fund Investment, but most importantly being a smart investor, you should be aware of the means to convert your risk in beneficial factors. Success without risk is a matter of fiction, and not real. Here, the benefit is, you know how to convert your risk in profit then why not to take the risk and secure your future with Mutual Fund Investment.
(Source: Various web sources)
#Names used in the article are fictional and are not concerned about any specific person.
*The write up is on best effort basis and the author doesn’t guarantee about its correctness. Any investment made based on this information will not make us responsible for the same.
(Mutual Fund investments are subject to market risk. Kindly read all the related documents carefully before investing. Illustrations are for example only, there is no guarantee of returns. Past performance is not an indicator/guarantee to future returns)