Sharekhan Blog

Are Mutual Funds Safe to Invest In?

  • Apr 17, 2024

But here's the million-dollar question - are mutual funds safe investment options for retail investors like you and me? Let's try to figure that out together in this blog.

What are Mutual Funds?

Simply put, a mutual fund is an investment that pools money from a bunch of investors and invests it in stocks, bonds and other such things. The fund is run by professional fund managers whose job is to make the best investing decisions to earn returns higher than market benchmarks.

Now, when you put your money in a mutual fund, you buy 'units' of that scheme based on the fund's objective. So, the money you invest goes into purchasing different assets. The value of your investment depends on how these underlying assets perform.

Know more about Hybrid Funds in detail

Types of Mutual Funds:

There are three main types of mutual funds based on where they invest:

1. Equity funds: They mostly buy shares of various companies with the aim of earning big returns over the long term. But with higher potential returns comes a higher risk of losing money.

2. Debt funds: They invest in fixed-income options like bonds, government securities, etc. These funds come with lower volatility and more stable but moderate returns. Hence, they can be considered as safe mutual funds to invest in.

3. Hybrid funds: As the name suggests, these funds invest in both equities and debt. So, they balance the risk-return equation, making them safe mutual funds to invest.

Benefits of Investing in Mutual Funds

Mutual funds have become popular amongst investors for some solid reasons:

1. Professional management: Qualified fund managers make all the investing decisions and put their market expertise to work.

2. Diversification: Funds invest across asset classes and securities, reducing overall risk.

3. Liquidity: Investors can redeem units and exit funds easily, as per the rules.

4. Flexibility: There are funds to match every risk appetite and goal.

5. Low costs: Expense ratios of Indian mutual funds are quite competitive.

6. Transparent pricing: You know the exact net asset value of your investment daily.

7. Regulation: SEBI keeps checks and balances to protect investor interests.

Risks Associated with Mutual Funds

1. Market Risk: Equity funds carry the highest risk as stock prices fluctuate frequently. Debt funds see lower volatility.

2. Fund Manager Risk: A fund's performance depends on the fund manager's expertise in stock selection and timing decisions.

3. Liquidity Risk: Closed-end funds and sectoral funds have higher liquidity risks.

4. Credit Risk: Debt funds carry a risk of default on interest/principal payments by bond issuers.

5. Concentration Risk: Thematic or sectoral funds carry higher risk due to a lack of diversification.

Is Mutual Fund Safe for Retail Investors?

While mutual funds do carry risks, they remain more favourable for retail investors compared to directly investing in equity or debt, especially for those new to investing. Here's why:

1. Rupee Cost Averaging: Through Systematic Investment Plans (SIPs), you can invest small amounts regularly in a mutual fund. This averages out the purchase cost over time and reduces risk.

2. No Special Skills Needed: Fund managers handle all the research, analysis and trading activities on your behalf.

3. Safety in Numbers: Your money is pooled with numerous other investors, leading to greater diversification.

4. Overseen by SEBI: Strict regulations by SEBI safeguard investors' interests and increase transparency.

5. Low Entry Barriers: Most funds have low minimum investment requirements, making them accessible for small investors.

How to Mitigate Risks When Investing in Mutual Funds?

While mutual funds themselves are well-regulated investment products, you can take certain steps as an investor to reduce risks:

1. Understand your risk appetite and investment goals before selecting a fund category and scheme.

2. Choose funds with a long track record and robust performance across market cycles.

3. Invest through SIPs over the long term to benefit from rupee cost averaging.

4. Maintain a balanced portfolio with a mix of equity, debt and gold funds.

5. Do not put all your eggs in one basket - diversify across schemes and fund houses.

6. Keep some funds in liquid and debt schemes to hedge against market volatility.

7. Track and review the performance of your mutual fund investments periodically.

Conclusion

While there are risks involved, mutual funds offer a relatively safe, low-cost, and convenient investment option for retail investors to participate in equity and debt markets. By following a disciplined approach, diversifying your portfolio, and investing for the long term, mutual funds can help you achieve your financial goals with lower risk. Do thorough research and consult your financial advisor before choosing the right mutual fund schemes for your portfolio.

Team Sharekhan
by Team Sharekhan

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