A Guide to the Long-Term Safety of Mutual Fund Investments

Mutual funds are the best investment products that diversify your portfolio with money from different investors. You can invest in a mutual fund by submitting an application form online or offline. However, one thing that most investors are concerned about is whether it is a safe investment option or not. Although mutual funds do not guarantee fixed returns due to being market-linked, you can mitigate the risk with due diligence, reviewing schemes, and ascertaining suitability. Here is a guide to the long-term safety of mutual fund investments.

Types of Risks Associated with Mutual Funds

Mutual funds, while offering diversification and potential value, carry inherent risks due to their investment in various financial instruments like equities, debt, and government securities. These risks are primarily due to market fluctuations affecting the Net Asset Value (NAV) of investments. Key types of risks include:

• Market Risk: Losses resulting from overall market downturns, influenced by factors like natural disasters, inflation, or political unrest. This systematic risk cannot be mitigated through diversification.
• Concentration Risk: The danger of investing heavily in a single scheme or sector, leading to significant losses if that particular investment underperforms. Diversification is crucial to minimise this risk.
• Interest Rate Risk: The risk associated with changes in interest rates, inversely impacting the price of securities, particularly bonds.
• Liquidity Risk: The difficulty in redeeming investments quickly without loss, common in funds with lock-in periods like ELSS or in ETFs with low market demand.
• Credit Risk: The risk that the issuer of a security will default on their promised payments, particularly relevant in debt funds that may include lower credit-rated securities for higher returns.

Investors must understand these risks and choose funds that align with their risk profile.

Factors that Make Mutual Funds a Safe Investment Avenue

Before identifying the safest mutual fund plans, it’s crucial to understand the factors that make mutual funds safe investment avenues. Secure mutual funds are less volatile and have more predictable returns. That means they have lower chances of experiencing losses over a short period, making them the most stable investment option. Mutual funds are safe investment avenues for the following reasons:

• Fund Management Under Professional Experts: Professional fund managers use research and analysis to manage mutual funds. They make sound investment decisions based on prudent research and due diligence. As an investor, you can avail of the services of a professional fund manager at relatively lower rates with mutual fund investments.
• Diverse Range of Mutual Fund Schemes: Many investors prefer mutual funds for investment due to the wider range of options available. You can choose a scheme most suitable to your risk appetite, financial goals, and investment horizon. Use a mutual fund calculator to select the best fund with appropriate returns and risk tolerance.
• Well-Regulated: The Securities & Exchange Board of India (SEBI) regulates the mutual fund industry in the country. The entity issues several regulations and guidelines for investor protection and awareness. The asset management companies in India must become members of the Association of Mutual Funds in India (AMFI), which aims to develop the country’s mutual funds sector while promoting and protecting unit holders’ interests.

Choosing the Safest Mutual Funds

Choosing the right type of mutual fund ensures the safety of investment. These are the safest types of mutual funds that investors with a low-risk appetite commonly choose:

• Money Market Funds: These are the safest types of mutual funds that invest money in low-risk, short-term securities like certificates of deposit, government bonds, and commercial papers. Even though they offer lower returns, they are extremely liquid. As a result, they are the most preferred options for investors looking for safe funds.
• Bond Funds: Bond funds are also safe investment options. They invest funds in fixed-income securities like corporate bonds, government bonds, and municipal bonds. The returns are higher than money market funds, but the risk is slightly more elevated.
• Index Funds: Index funds are safe options because they have a low expense ratio and are highly diverse. By tracking a market index, they spread the risk across various investment avenues. Since professionals manage these funds passively, their fees are also lower than actively managed funds.
• Balanced Funds: These funds invest money in a combination of bonds and stocks, spreading the risk across various investment types. They are safe avenues as they provide a balance of return and risk, making them a better option if you want to invest in the stock market without compromising on stability.
• Target-Date Funds: These are the best funds if you want to invest and save for specific goals like retirement. They automatically adjust asset allocation by the target date, becoming increasingly conservative over time. They are safe due to a diverse mix of investments that minimise the risk by the target date.

Should You Invest in a Mutual Fund?

Mutual funds are safe investment options if you understand them well. As an investor, you should not worry about short-term fluctuations in the returns. Choose the right fund scheme that syncs with your investment horizon and goals. Before investing, gain information about mutual funds and research to compare and select the right fund type.

Mistakes to Avoid When Investing in Mutual Funds

Avoid these mistakes to make mutual funds a lucrative investment option for your goals:

• Treating Mutual Funds Like Equity Shares: Many beginners who are allured by high short-term returns perceive mutual funds as stock investing. Don’t forget that fund managers build your portfolio with mutual funds after rigorous research. A stock’s value may rise or fall, but it does not work the same way as mutual funds. So, avoid buying or selling a mutual fund for trading purposes.
• Expecting Guaranteed Returns: Mutual funds do not deliver guaranteed returns. The returns they generate fluctuate according to the market volatility and macroeconomic environment. Even risk-free debt funds do not provide assured returns. So, expecting guaranteed returns from mutual funds is a mistake.
• Assessing Only Past Performance: A mutual fund’s past performance does not solely guarantee a fund manager’s efficiency. If a fund performed well in the past, it does not mean it will succeed in the future, too. So, do not use past performance as the sole criterion to select a mutual fund for investment.
• Redeeming the Fund Too Early Based on Market Noise: Market noise often creates a panic condition that causes many investors to redeem their funds as quickly as possible, even at a loss. Avoid following what others are doing. The market always rewards investors who maintain patience with their investments.

Gaining information about the mutual fund you invest in is crucial to ensure safety with your investment. Not having proper knowledge leads to committing mistakes during the investment journey, making the investment riskier. While bond, money market, index, balanced, and target-date funds are safer investment avenues, you must choose them wisely to mitigate risk and make informed decisions.

Disclaimer: This article is part of a sponsored content programme. The Tribune is not responsible for the content including the data in the text and has no role in its selection.