With investment in mutual funds being the preferred choice of investors, it is vital to know if mutual funds are safe.
Since mutual funds are associated with high returns, the risks involved with them cannot be ignored. It is therefore recommended, to understand how mutual funds work and which mutual funds are best.
How does Mutual Funds Work?
To understand how mutual funds, work we must know that Mutual funds are promoted by both public and private sector companies. Guided and monitored by the Securities and Exchange Board of India (SEBI), the strategy of mutual funds is designed by seasoned fund managers.
Mutual Fund is comprised of a portfolio that invests in bonds, securities, government securities, and cash.
Are Mutual Funds Safe?
If safety is measured by the presence of any regulating authority, mutual funds meet that condition perfectly.
Two parameters that raise the risk factor for investment in mutual funds are:
Protection of Invested capital
- Mutual funds are managed by a team of proficient fund managers who make mutual fund investment easy for the naive investors too.
- The investment in diversified funds rather than a single fund maintains the balance between risk and returns.
- The option to select and switch funds as per requirement minimize the risk with the diversification of funds.
Safety from Fraud
- Like banks are regulated by the RBI, mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI).
- SEBI formulates policy guidelines from time to time and supervises the working of mutual funds to ensure the welfare of investors.
- Investors’ money remains safe since mutual funds must follow the rules laid down by SEBI and under no circumstances can a company disappears with the investor’s money.
Risks Linked with Mutual Funds
This risk arises from the volatility or downswing of the market. Natural calamities, political unrest, inflation, etc are some factors that affect the market and investors’ portfolio performance.
Interest Rate Risk
A rise in interest rate leads to a fall in the price of securities and vice versa
It refers to the risk associated with debt funds (generally), wherein the issuer is unable to make payment as per the interest quoted before. A firm having a high credit rating lowers this risk.
This risk arises when an investor is unable to redeem the invested funds without bearing any loss or a seller is unable to sell his securities due to the unavailability of any buyer.
Categorization of Mutual Funds based on Risk Level
To simplify the fund selection for relatively new investors, AMFI has categorized funds based on its risk level.
High-Risk Mutual Funds
These are the funds whose performance and returns are linked to the market position. Funds such as International funds, thematic funds, and Sectoral funds are examples of High-risk mutual funds.
Moderately High-Risk Mutual Funds
These funds have a large portion of investment in equity instruments and are ideal for investors who can stay invested for a longer period. Most of the large-cap funds fall under this category.
Moderate Risk Mutual Funds
These funds are ideal for investors who want to stay safe and earn decent returns. The exposure to risk is restricted and hence returns are also limited. Investment in these funds must be done for medium-term or long term.
Moderately Low-Risk Mutual Funds
These funds have a shorter time horizon of 2-3 years and are ideal for investors with a similar investment period. The investment of funds under this category is done in short term securities and bonds, leading to low risk and low returns.
Low-Risk Level, Mutual Funds
These funds are the safest out of all funds as the investment of these funds is done in government securities and gilt funds. Even though the returns are low, the funds are ideal for people looking for safer options for returns.
Stocks vs Mutual Fund – Better Returns
While discussing mutual funds, let’s compare their performance with Stocks which is another popular form of investing in the market.
Investing in stocks is like buying a share of a company. When buying a stock, an investor has to equip himself with the knowledge to carry out the investment and monitor the share market, company performance, and accordingly trade funds. If an investor wishes to buy 10 different stocks he must be aware of all related to information and guidelines in the market that may affect the share prices.
However, in case of mutual funds, this task is performed by the fund manager and instead of investing in 10 different stocks, an investor can invest in 4-5 different mutual funds with different risk profiles and earn good returns