In recent years, mutual funds have gained popularity as a preferred investment option for many individuals. Managed by professional fund managers and offered by reputable industry leaders, mutual funds provide transparency in terms of fee structure and investment details.
However, it’s important to recognise that every investment carries inherent risks.
Mutual funds can be broadly categorised into equity mutual funds and debt mutual funds, each with its own set of specific risks.
Elderly investors need to be aware of these risks when considering mutual fund investments. By understanding the potential risks involved, investors can make informed decisions and take necessary precautions to safeguard their investments.
Let’s explore the risks associated with mutual fund investments that senior citizens should be mindful of, thus ensuring a prudent approach to their investment choices.
RISKS INVOLVED IN EQUITY MUTUAL FUNDS
The returns from equity mutual funds are affected by two factors, namely market risk and company risk.
Market Risk: Market risk impacts the entire market. Thus, it’s crucial for investors, including senior citizens, to understand that market risks are beyond the control of individual companies or sectors. These risks also highlight the importance of diversification and why it is necessary to consider a well-balanced portfolio that can withstand market fluctuations.
By spreading investments across different asset classes and sectors, investors can mitigate the impact of market-wide risks, and potentially safeguard their investment portfolios.
Company Risk: Company risk is individual risks that emanate from a company. Government policies concerning specific sectors and factors specific to a company may impact the returns by mutual funds investing in such companies. For example, if a mutual fund has invested in a specific pharma company along with others, any adverse findings by US FDA will impact the stocks of the company, and hence, the returns by the mutual fund.
By keeping a well-diversified portfolio and regularly reviewing the fundamentals and developments of the companies held within their mutual funds, investors can better navigate company-specific risks and strive for long-term investment success.
RISK INVOLVED IN DEBT MUTUAL FUNDS
Debt mutual funds look risk-free at first glance because the debts or bonds declare the applicable returns beforehand. There are two types of bonds, namely corporate bonds and government bonds. Mutual funds can invest in either of them or a combination of both.
Government bonds do not default on their payment, so they are almost risk-free. The government has always paid to its bondholders. Similarly, corporate bonds from blue chip companies are safe, as they have a history of paying their obligations on time.
Nevertheless, debt funds also carry risks.
Interest Rate Risk: Though government bonds and corporate bonds by blue chip companies have practically no possibility of default, but there is another risk involved. There is interest rate fluctuation risk in such bonds or mutual funds that invest in such bonds.
A rise in interest rate reduces the price of the bonds, which in turn reduces the net asset value (NAV) of debt mutual funds.
Credit Risk: If a debt mutual fund invests in bonds offered by average companies, there is always the risk of default by the companies because of a bad business environment or company-specific problems.
Credit risk arises when the fund invests in bonds, debentures, or other fixed-income instruments issued by various entities, including corporations and government bodies. These investments are subject to the creditworthiness of the issuer.
If the issuer’s financial health deteriorates or if there are adverse developments affecting their ability to repay the borrowed funds, there is a heightened risk of default. Investors should carefully review the credit quality and rating of the underlying securities in a debt mutual fund before investing.
There can be more risks involved in the mutual fund investments, but the senior citizen investors can lower the risk by diversifying their investments across different categories of mutual funds, and by doing a thorough research before investing in a mutual fund.
Senior citizen investors may take the help of an investment advisor to reduce the risks involved in mutual fund investments.
The author is an Independent Financial Journalist