Risks involved in Mutual Fund investment – Concentration, Interest Rate, Liquidity and Credit risk

What type of risks are involved in Mutual Fund Investment

Mutual funds are considered a relatively safe investment vehicle, but their performance depends on general market volatility. As with any system, investing in a Mutual fund is risky. Investment in mutual funds flows into various financial products through fund managers.

The risk of investment in mutual funds depends on many factors that affect the value of securities, such as government economic policies, the current economic situation in the country, and the output gap. To maximize your return on investment, you need to choose your Mutual funds wisely.

Risks involved in Mutual Fund Investment

Market risk

Market risk is the risk that can result in losses to investors due to underdeveloped markets. There are many factors that affect the market. Some examples include natural disasters, inflation, recession, political instability, and interest rate fluctuations. Market risk is also known as systematic risk. Diversifying a person`s portfolio won`t help in these scenarios. The only thing that an investor can do is to wait for the things to fall in place.

Concentration Risk

Concentration generally means focusing on just one thing. Concentrating a considerable amount of a person`s investment in one particular scheme is never a good option. Profits will be huge if lucky, but the losses will be pronounced at times. The best way to minimise this risk is by diversifying your portfolio. Concentrating and investing heavily in one sector is also risky. The more diverse the portfolio, the lesser the risk is.

Interest Rate Risk

Interest rate changes depending on the credit available with lenders and the demand from borrowers. They are inversely related to each other. Rising interest rates during the investment period can lead to lower securities prices.

Liquidity risk

Liquidity risk refers to the difficulty of recovering an investment without degrading the value of the product. Also, the seller may not be able to find a buyer for the security. For investment funds such as ELSS, the block period can lead to liquidity risk. You cannot do anything during the embargo.

In other cases, exchange-traded funds (ETFs) may suffer from liquidity risk.

Credit risk

Credit risk means that the issuer of the system is unable to pay the promised interest. As a general rule, institutions are rated by rating agencies according to these criteria. As a result, highly rated companies pay less and vice versa. Mutual funds, especially debt funds, also suffer from credit risk. For fixed income funds, the fund manager should only include investment grade securities. However, in order to achieve higher returns, fund managers may include securities with lower ratings. This increases the credit risk of the portfolio. Before investing in a debt fund, you need to check the credit rating of your portfolio structure.