Mutual Fund
It is a collective fund. It is where the professionals manage the money of the investors who are ready to invest their money. The advantages in the mutual funds are the investment is diversified, the liquidity level is high, it is very simple and easy to understand and operate and there is always a check by the government.
It means the possibility to lose the principal or interest or sometimes both. So one has to read the offer document properly before investing in mutual funds.
There is always a relation between the potential return and the risk. This is very commonly known as the risk return trade off. This means when one takes a higher risk they can expect a higher return and vice versa.
As long as the mutual funds are concerned the risk that you take will be based on the time that you are planning to invest your money. In case you opt to invest for a longer time the market will be more stable and you will be taking a lesser risk. If the investment in the mutual fund is for a shorter time you are more open to the risk and the volatility of the market so you will be taking a higher risk.
Each mutual fund has different characteristics and hence the kind of risks that is associated with each of them will also be different. Let us explain this with the help of examples both the bond as well as the stock fund has very low risk in their respective category but they cannot be compared or treated the same. Stock funds have a slightly better return than the bond funds.
Of all the assets the money market investments are the best and they are very stable. The price sings of the bonds are very high when considered for a short duration. When they are invested for longer periods they get very good returns.
The risk of the mutual funds totally depends on the type of the investment that is held. Say for instance the risk that a bond fund will face is an income and interest rate risk. They are inversely related which means when the interest rates go up the price of the bond value will go down and when the rate interest comes down the price of the bond will go up. The bond income is also based on the interest rate.
Similarly a sector stock fund will have more risk. It means a fund that is invested only on one industry. However if the investment is diversified over many industries then the risk is lower.
Some of the risks that are associated with the mutual funds are listed below.
Call risk – this is one of the types of the risks that is involved with the mutual funds. When the rate of interest falls the person who has issued bonds will redeem or otherwise known as go for the call option. The issuer has the right to redeem it before the maturity rate. So when the interest rate is low they will redeem at the best value.
Country risk – this is another risk which rises because of the political events like war or change in the government leading to change in policies,, natural disasters like earthquake or floods or financial issue like issues due to inflation. All these will definitely reduce the investments as well as the value of the investments.
Credit Risk – there is small possibility that the person who has issued the bond might not return the interest or the capital as well.
Currency Risk – there can be fluctuations in the market because of the fluctuations in the currency.
Income Risk – when there is a fall in the interest rate there are chances the dividend income from the fixed income funds may reduce.
Industry risk – when there is a development in the industry there are chances that the value of the stock that is associated with that industry will reduce.
Inflation risk – when the cost of living increases then the funds that have returns after the inflation adjustment is done will face a lot of risks.
Interest rate risk – when the rate of interest increases then the value of the bond will reduce. This again is a risk which is associated with the funds.
Manager Risk – there are some chances that the person who is managing the funds might not invest it wisely. This is a very big risk so choosing an advisor has to be done carefully.
Principal risk – there are remote chances that of losing the principal.