If you are a newbie looking for ways to invest money, you might have heard about mutual fund schemes having a standard disclaimer - ‘MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.’
Dig deeper into the types of mutual funds, and you will find a significant risk factor associated with equity funds that may also provide high returns. For a layperson, it brings forward the indirect correlation between equity funds and high returns.
However, irrespective of the bells this correlation rings in your mind, you must first understand the underlying truth about equity fund risks. Whether a beginner or an experienced investor, it would be fair not to assume that selecting risky funds would eventually lead to significant returns.
Want to understand it further? Let’s begin with the fundamentals of equity funds.
What are Equity Funds?
At their core,
equity funds invest primarily in the stocks of different companies. The selection of stocks under the scheme is based on the overall scheme objective. These types of mutual funds can be considered for capital appreciation over the long term. If you are willing to take higher levels of risk while expecting long-term wealth creation, you can choose to invest in equity funds.
Furthermore, these funds are further classified into large-cap, mid-cap, small-cap, and multi-cap funds based on the market capitalisation of companies in whose stock they invest.
How Are Risk and Returns Related to Equity Funds?
The risk involved in equity funds is determined by the stocks chosen for the scheme. Since mutual funds are market-linked, the value of the underlying stocks moves along the market fluctuations. Eventually, the impact is reflected in the Net Asset Value (NAV) of the fund you have invested in. Depending on the selection of
mutual funds in your investment portfolio, you will eventually receive cumulative returns over the period you stay invested.
Wondering if there is a simpler way to understand equity fund risk? There is. The risk factor is nothing but the chance of getting returns on your investments in equity funds as expected. In reality, you may or may not receive the anticipated returns because of the various risk types involved.
Different Types of Risks Involved in Equity Funds
1. Risk of price
Equity shares and equity related instruments are volatile and prone to price fluctuations on a daily basis. Like many other market-linked securities, the performance of equity funds can also be unpredictable and volatile, particularly in the short term. Here, it is important to note that the impact can be significant in the short term. However, when you invest in these funds to achieve long-term financial goals, the tenure of investment has the potential to reduce the risk, hence keeping your investments relatively less affected by short-term market volatility.
At any time, the prices of stocks can fluctuate up or down to affect the
mutual fund NAV . Hence, carefully considering this type of equity fund risk makes sense.
2. Liquidity risk
The liquidity of investments made in the equities may be restricted by trading volumes and settlement periods. Settlement periods may be extended significantly by unforeseen circumstances. While securities that are listed on the stock exchange carry lower liquidity risk, the ability to sell these investments is limited by the overall trading volume on the stock exchanges. The inability of a mutual fund to sell securities held in the portfolio could result in potential losses to the scheme, should there be a subsequent decline in the value of securities held in the scheme portfolio and may thus lead to the fund incurring losses till the security is finally sold.
You can minimise or mitigate the risk of liquidity by thoroughly checking the equity funds you want to invest in.
3. Macroeconomic risks
These risks are multifaceted and related to a slowing economy that has the potential to result in reduced demand, lower profit margins, and affected profitability. Some factors related to equity fund investments are interest rates, inflation, or the corporate earnings of the company or stock included under the chosen mutual fund.
Macroeconomic risks have an impact on all market-linked investments, including equity funds. As mentioned above, a comprehensive analysis of the funds you want to choose will give you a better understanding of building a financially-healthy portfolio.
Summing It Up
Investing in equity funds does involve various types of risks. But when you take the time to understand the working of different types of funds and invest strategically, you can prevent a big hit on your capital in the long run.
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.
