“Mutual funds are subject to market risk. Please read the offer document carefully before investing.” We have all heard this disclaimer in the advertisements related to mutual funds (MF). But is market the only mutual fund risk that affect investments?
Stock market performance is dependent on a number of factors and shares are considered to be a riskier option as compared to bonds. Depending on the exposure to the various industries, there are certain risks involved in mutual funds investments.
1. Market Risk
The market is a vulnerable place and the income generated by securities may increase or decline, depending on certain events. General economic conditions, global market conditions, performance of companies, regional or global economic instability and fluctuation in interest rates are some of the factors that can cause ups and downs in the markets and thereby on one’s mutual funds investments.
2. Credit Risk
If the borrower is unable to return the sum in a said amount of time, then it is termed as a credit risk. It includes payment of interest or repayment of capital or any other financial or legal obligation. It is also termed a credit risk if the money is not paid back in full.
3. Interest Rate Risk
An investor is not generally bothered by fluctuating interest rates unless availing a loan or putting money away in a fixed deposit. But when investing in mutual funds, interest rates and bond prices are inversely proportional. It means that when interest rate falls, bond prices increase, and vice versa. Thus, the value of the fund either appreciates or depreciates depending on the interest rates. Hence one must be aware of the interest rate cycle before investing in the funds.
4. Liquidity Risk
This risk stems from the lack of ability to convert the investment into cash easily and without loss at a given point. In these cases, the security is forced to be sold at a lower price than it’s worth due to liquidity constraints. Doing this can have a negative impact on the performance of the mutual fund.
5. Price Risk
Equity markets can be very volatile in the short term. Hence, a look at price risk becomes vital as it can move in any direction. Price risk can adversely affect your fund. It is advised to invest in long-term mutual funds schemes to be safe from short-term volatility.