What are the risks of investing in a Mutual Fund?
Investors tend to opt for risk-free financial instruments like fixed deposits or recurring deposits when they begin their investing journey. While these instruments offer guaranteed returns, they are unlikely to help achieve your financial goals, given the inflation rate. Hence, many financial institutions recommend amateur investors to invest in financial instruments like mutual funds.
As novice investors, it is natural to be concerned about the risks involved while investing your hard-earned money. One of the first questions you would want to ask your financial advisor before investing in mutual funds is whether or not it is safe to invest in mutual funds. Let's find out!
The risks involved in Mutual Fund Investment
When you invest in a mutual fund, there are two major concerns - will you be able to accumulate enough capital gains without losses and whether the asset management company handling the pooled funds is trustworthy. For the latter part, all domestic mutual funds are regulated and monitored by two regulatory agencies–the Securities Exchange Bureau of India (SEBI) and the Association of Mutual Funds in India.
Top factors to consider while checking for Mutual Fund Safety
The second major concern while investing in a mutual fund is the risk. There is a certain element of risk involved while investing in mutual funds as their outcome is linked to market volatility. However, there are a lot of factors that you should consider while analysing the risks of various mutual funds:
1.Returns
A well-managed mutual fund has the potential to earn capital gains as high as 12%, which is nearly double what traditional financial instruments like fixed or recurring deposits offer. The main aim behind a mutual fund investment is to exploit the securities markets and earn returns as high as possible. In essence, this allows investors to plan for specific financial goals, including education for their children, planning family vacations, buying a new home, retirement planning etc.
2.Uncertainty Factor
Mutual fund investments using a systematic investment plan (most popular among investors) are a lot safer because they factor in the uncertainty. What if there is a family medical crisis and the investor cannot afford to invest the SIP amount for that month? In such a situation, the investor can pause the SIP and start investing again when they have enough funds. On the other hand, if you don't have enough funds to invest in a recurring or fixed deposit during a particular month, your recurring deposit stands cancelled.
3.No dependence on a loans
Let's say an investor has been investing in a mutual fund for ten years and has been receiving significant capital gains. But, now the investor wants to send their children abroad for higher education. With an education loan, the investor has to pay a high-interest rate (12% in some cases) to the bank. But what if the investor didn't have to opt for a loan? All they would have to do is withdraw from the mutual fund they have been investing in and use the capital gains (potentially 12% or higher) to fund their children’s education.
4.Tax Benefits
Mutual funds are tax-efficient in comparison to traditional financial investment instruments. The short term and long term gains from a mutual fund are taxed so that investors don't end up paying a significant chunk of returns as tax. Additionally, some mutual funds, like the equity-linked savings scheme or ELSS, are specifically designed to cater to tax savings.
Conclusion
If you are still unconvinced, you can always invest in mutual funds that cater to your risk appetite. If you are keen on higher returns, you can invest in equity securities in mutual funds. Additionally, if you have a low-risk appetite and still wish to invest in mutual funds, you can always invest in debt funds that offer low risk and low returns. You can invest in hybrid mutual funds for a healthy mix of both.