This is part of our Mutual Funds series having the end goal to give you a hollistic understanding of what mutual funds are and how you can take advantage of it. For this post we would be discussing the Risks of Mutual Funds Investing
Risk is defined as a probability/threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal factors , and that may be avoided through preemptive action.
Risk is present everyday and everywhere as long as we are living. We can not avoid risk but we can minimize it. If there are risks in life, there are also risks in investments. There is no such thing as risk-free investments and mutual funds is not immune to risk.
The following major risks associated in mutual funds investing are:
1. Market risk. Mutual funds are marked to market, meaning they are dependent on the fluctuation or volatility of the market. Mostly affected is the equity-laced mutual funds as the stock prices fluctuate daily positively or negatively by a big margin. The only way to ride out the fluctuation is by investing for the long term as historically, stock prices have been proven to be on an upward trend over the long term.
2. Liquidity risk. There are always going to be some stocks in the portfolio which may not be that liquid and also it depends on the nature of fund that you are invested in. For example, if you are invested in a large cap stock there there is no problem of liquidity because all these large cap stocks are quite liquid (easy to sell back and get your money), but if you are invested in a small cap fund the liquidity is going to be an issue.
3. Credit Risk. What is that credit risk? When you invest in a bond mutual fund, the money is ultimately invested in debt securities. Every security is actually rated. Make sure that when you invest in a fund, the fund has invested in higher grade investment securities because the company can default in terms of paying interest or principal or both.
4. Interest rate risk. This kind of risk is inherent in bonds. Bonds and interest rates are inversely proportional. An increase or decrease in interest rate will result to a decrease or increase in bond yield.
5. Inflation risk. This refers to the possibility that the value of an asset will decline due to inflation which shrinks the value of a currency. Because inflation can cause the purchasing power of cash to decline, investors may want to consider investments that appreciate, such as growth stocks or bonds designed to stay ahead of inflation long-term.
6. Other risks. There are other minor risk such as business risk, currency risk, political risk, geographical risk. Most of all, these risks will be handled by the fund manager. If the fund manager is good, then expect the fund to perform well. Although the choice of a fund manager is also a risk factor, most often than not, there is a research team that will back up the decision of the fund manager in making our money grow.
Edmund Lao is a Registered Financial Planner who has a passion to help Filipinos invest and right way and avoid being scammed. He is known by many as the “SCAMCROW” loved by investors feared by scammers. His passion is to save Filipinos from scams and teach them to invest properly in stocks, bonds, and mutual funds. He owns the website wealth-wonder-boy.blogspot.com.
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