Mutual funds are a preferred investment choice for many investors today due to the comparatively lower level of risk involved. There is a fund manager, who is a financial expert, managing your money, making all the investment decisions of what to buy, when to exit, how to respond to changing market conditions, etc., strategically. Hence, once you have done your research on choosing a mutual fund that aligns with your financial goals, your involvement can be minimal as the fund manager makes all the important calls.
But have you ever thought about how mutual funds got this lower risk characteristic? Let’s examine some factors that help mutual funds manage their risks.
Diversification
Diversification is often considered the key selling point of a mutual fund plans. A mutual fund invests your money in different financial securities, according to the theme and objective of the fund and hence, even a major dip in one or two securities will only have a diluted effect.
Let’s understand this better with an example. Suppose you are invested in a company with a stock price of Rs. 1,000 as of the previous day’s close. At the end of the current day, the stock closed with a 25% loss. This could give you a loss of Rs. 250. At the same time, consider this stock is a part of a mutual fund with a Net Asset Value (NAV) of Rs. 1,000 as of the previous day’s market close.
Let’s imagine that this stock was 10% of the total mutual fund’s portfolio. That means, the representation of this company’s stocks in the mutual fund’s NAV is only Rs. 100. If the stock has lost 25% means the loss is 25% of Rs. 100, which is Rs. 25. At the current day’s close, if you consider that all other securities in the fund had the same price as of the previous day for ease of calculation, your loss will be limited to Rs. 25.
Dynamic portfolio
Mutual funds are known to have a dynamic portfolio. That means the fund manager makes changes in the asset allocation of the fund to make the most out of your investment. Here, the changes would also reflect the character of the fund. For example, if it’s a low-risk fund, the fund manager will bring about changes that will enhance capital protection.
In the case of balanced advantage funds, this is truer. In a balanced advantage mutual fund, the fund manager has the liberty to switch between equity and debt securities to make the most out of your investment. The manager may invest more in equities during a bullish period but when there is more risk involved, your investments could be switched to lesser risky options such as bonds to mitigate the risk.
Flexibility
Even though there might be fees like exit load, you can exit your current mutual fund investment anytime if you feel like there is more risk involved and invest that money somewhere else, making mutual funds liquid. Here, your own research and knowledge are the key to making sure your money is safe. You can choose or switch to funds that match your risk appetite.
How to lessen mutual fund risk?
Risk is subjective. What might be a risk for you could be fine for someone else. Hence, finding your risk appetite is crucial. Your risk appetite depends on several factors such as your age, income, financial responsibilities, personality, etc. It’s essential to invest according to your risk appetite to meet your financial goals effectively. You can consult a financial expert who can help you figure out your risk tolerance and the investments you should make accordingly. Don’t waste any time, figure out your risk appetite and start investing today!
