Last week, we talked about what equity mutual funds are all about so today we wanted to talk a little more about the common perception of mutual funds in general and equity mutual funds specifically.
Equity mutual funds are to this day seen as a ‘risky investment’, which is why many people choose not to invest in them their entire lives. If you have a low-risk appetite, that may even be a good decision, but that’s not the point. Every investment involves risk to some extent and there are many factors that make an investment more or less risky.
Since mutual funds invest in a number of different securities, each mutual fund portfolio’s risk level is dependent on the securities that have been invested in. As mutual funds are market-linked, as the market fluctuates one way or the other, the value of the stocks moves along with it and is reflected in the Net Asset Value (NAV) of the fund. Risk is essentially the chance of you getting returns on your investment as expected. When it comes to equity mutual funds, you may or you may not receive returns as expected because of the risks involved.
Here’s what they are:
1. Risk of price: Like other market-linked securities, equity markets can be unpredictable and volatile in the short run of things. Prices can fluctuate up and down, affecting the NAV of the fund you’re investing in so it is definitely important to consider this risk carefully.
It is, however, essential to note that this is, once again, the risk involved when you invest in the short term. When you invest for the long run and invest strategically to achieve certain financial goals, your approach and the term of investment offset the risk so you remain unaffected by short term volatility in the market or the price.
2. Risk of liquidity: This risk comes up when you find yourself unable to sell a stock at a price that you wanted (liquidate your assets). Liquidity risk generally occurs when the fund’s portfolio contains investments in securities that aren’t traded very often or that have a minimum lock-in period during which no transactions are allowed or there costs associated with making transactions at the time. In such situations, the manager of the fund in question has no choice but to hold on to the stock and, if it comes to it, sell it at a much lower price, which is what results in losses.
Liquidity risks arise when specifically dealing with a certain kind of stock or security. Doing a thorough and holistic evaluation of the mutual fund you invest in, like it’s current holdings, the performance of the fund in previous years, as well as the expected performance in coming ones (since history doesn’t always repeat itself), will mitigate this risk.
3. Macroeconomic risk: Macroeconomic risks are caused by a multitude of factors. Some of them are the corporate earnings of the company or stock you’ve invested in, inflation, interest rates, or growth. Whatever the factors may be, they affect the entire portfolio and its value. So when the economy, on the whole, is doing well, the fund you’ve invested in will do well too. On the flip side, when the economy isn’t in great shape, this proportionately affects the NAV of the fund you’ve invested in.
Macroeconomic risks accompany all market-linked investments, though this is more true for equity mutual funds than other investments. That being said, as mentioned earlier, doing thorough analysis or the funds that you want to invest in will leave you with a much better understanding of which securities are performing consistently and are able to weather the macroeconomic factors that are involved.
While investing in equity mutual funds does involve the risks mentioned above, when done in an informed and strategic manner, the risk you take on decreases. Always do your homework before investing in any fund and ensure that the goals and strategies of the fund align with your own financial goals in the long run and not the short term. Doing this will not only help you gain a deeper knowledge of the market but also ensure that you show handsome returns on your investments.