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We know that every financial investment is subject to market risk. A Mutual Fund is one of the instruments that carries benefits and risks. In the previous article, we gave information about the benefits of investing in Mutual Funds. In this article, we will see some risks associated with Mutual Fund investment, how these risks affect your return on investment, and how to mitigate these risks.

Which type of risk is involved in Mutual Funds?

Management Risk:

 Mutual Fund investment is managed by skilled professionals who are responsible for making important decisions regarding deployment investment. They diversify portfolios through their analysis and strategies. If the fund manager makes the wrong decision, it can lead to heavy losses.

How to mitigate Management Risk?

Find the best fund manager, by studying its historical performance fund manager. Invest money where the role of fund manager is less.

Market Risk:

Negative sentiment in the market occurs due to global news, geological events, sanctions, the relations among the countries, disasters, and invasions made by different countries, which leads to high volatility in the market, these market fluctuations affect the overall performance of the Mutual Fund.

Ex. Index Fund 

How to mitigate Market Risk?

Market risk affects the overall value of the mutual fund. There is no sustainable mitigation that works properly for market risk, but we can reduce losses by diversification and hedging of investment.

Inflation Risk:

Inflation leads to higher prices of goods and services which indirectly affect the purchasing power of investment or currency over time.

Ex. If inflation is growing 4% yearly and if your mutual fund investment generated 3% return. It shows that your investment can't beat inflation.

How to mitigate Inflation Risk? 

To avoid inflation risk, invest in equity Mutual Funds and inflation-protected securities.

Currency Risk:

Currency risk is also called as foreign exchange risk. It depends upon the foreign exchange rate and the economy of the country. Currency risk comes into role when mutual funds invest money in the foreign asset. When the currency exchange rate of the country falls, then mutual fund investment will face losses and vice versa.

Ex. Global Equity Fund

How to Mitigate the Currency Risk?

Diversification and hedging of different foreign assets, and investments in the country having a stable economy.

Liquidity Risk:

Low-liquid assets like real estate or private company stock don’t have enough volume for buying and selling which leads to lower returns or losses.

How to mitigate liquid risk?

Invest in the mutual fund which focuses on most liquid assets. PSU stocks are one of the most liquid assets in the Indian stock market.

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Interest Rate Risk:

Interest rates directly affect the mutual fund investment. If the interest rate increases, it ultimately decreases the overall bond value and vice versa.

How to mitigate Interest Rate Risk?

Reduces the time duration of a particular fund, which reduces the interest rate.

Reinvestment Risk:

Reinvestment risk is particularly relevant for bond fund investors who rely on periodic interest income. This risk occurs when the proceeds from a bond or another investment are reinvested at a lower rate than the original investment. 

Tax Risk:

Tax risk involves the possibility that changes in tax laws or regulations could negatively impact the returns of mutual funds. For instance, changes in capital gains tax rates, dividend tax rates, or other tax-related policies can affect the after-tax returns of Mutual Fund investments. 

How to Mitigate Tax Risk?

Staying informed about potential tax changes and consulting with a tax advisor can help investors manage this risk. 

Conclusion:

All the investments in the market are subject to market risk. Mutual Fund offers a diversified portfolio and professional portfolio management but it is not enough to reduce the complete risk. The key risks associated with mutual funds include market risk, credit risk, interest rate risk, liquidity risk, management risk, inflation risk, and currency risk. While these risks cannot be entirely avoided, they can be mitigated through the right diversification of stocks, careful fund selection, and working with experienced fund managers.  

FAQ:

1. What is the dark side of Mutual Funds?

Ans: Mutual Funds come with hidden fees that eat into long-term returns. They can also be tax-inefficient, with capital gains distributions affecting your tax bill. What's unique is that investors have no control over the specific assets held, and fund performance can vary widely based on the manager's strategy.

2. Is the investment in the Mutual Funds safe?

Ans: Mutual Funds are considered relatively safe because they invest in low-risk, short-term debt instruments like government securities and high-quality corporate debt. However, they're still not entirely risk-free, as credit risk or interest rate changes can cause fluctuations.

3. Which Mutual Fund gives 100% return?

Ans: There’s no Mutual Fund that can promise a 100% return, as such high returns are typically tied to high risks. However, funds that focus on high-growth sectors like tech or emerging markets can experience rapid growth during favourable conditions, but it carries high risk.

4. Which Mutual Fund has more risk?

Ans: Every Mutual Fund carries some risk. In India, small-cap funds are considered high-risk high-return funds. 

 5. Is a Mutual Fund more riskier than a Stock?

Ans: Mutual Funds include diversification of portfolio.it is considered less risky as compared to stocks.

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