Are Mutual Funds Safe
What is meant by “safe investment”?
Before we jump into explaining the safety function, let’s first find out the risks associated with investments. Market risk, credit risk, inflation risk and liquidity risk are some of the common risks feared by investors. Thus arises the dilemma- are mutual funds safe?
Well, yes they are safe because they come with a diversification feature. Does that mean that you are not taking any risk while investing in mutual funds? Not quite, mutual funds are subject to risks that you voluntarily choose to take.
With mutual funds, you can choose not to put all your eggs in the same basket. In simple terms, mutual funds allow you to invest in multiple asset classes based on your risk-taking capacity. Your risk-taking ability or your risk-appetite can determine your choice of funds. You can also manage these risks by balancing your portfolio.
You can handle the risks associated with mutual funds by:
- Adding debt to balance the market risk in equities
You might be aware of the market ups and downs, or what is known as market volatility. While investing in equities, you face short-term market volatility. To balance this risk, you can add debt-based funds to your portfolio.
Risk in debt funds is considerably lower than equity funds. Thus, your portfolio is now diversified with a mix of high returns (equities) and low risk (debt) investments.
This debt-equity proportion can vary according to your goals and age.
- Adding equities to balance the credit and inflation risk of debt
Debt funds have a lower risk than their equity counterparts. However, you face risks like inflation risk and credit risk while investing in these assets.
You can balance these investments by adding equity funds to your portfolio. Equity funds offer higher returns that can beat inflation and fulfil your long term goals. Thus, the risk of not meeting your financial goals is balanced by the high returns of equity investments.
- Investing in Hybrid Funds, and their in-built diversification
Some mutual funds come with an in-built diversification feature. They invest in different assets, like equity and fixed income securities, to provide balanced returns. Therefore, you get a combination of high-returns from equities and a lower risk from fixed income securities. You can choose the proportion of equity and fixed income assets through different types of hybrid funds.
- Choosing Liquid Funds for emergencies
Apart from managing different investment risks, mutual funds can also protect you from uncertainties. Liquid funds are low risk, debt-based funds which can be redeemed anytime. They can be your alternative to your savings bank account, as they offer higher returns. Therefore, mutual funds can help you balance not only investment risk, but also manage financial emergencies.
Mutual funds, with their diversification feature, can manage all kinds of investment risks. Therefore, they can be considered as safer investment options as compared to direct equity or debt investments.
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