Your Money: Types of mutual funds and the risks they carry

Always go for a diversified portfolio that comprises equity, debt and gold asset classes in order to minimise your risks

It simply means the risk which may cause losses for an investor due to the poor performance of the market.
It simply means the risk which may cause losses for an investor due to the poor performance of the market.

By Sandeep Bhosle

We all grew up watching our parents and their parents put all their extra money into fixed deposits (FDs). However, FDs no longer shine as before. In recent years, mutual funds have emerged as a frontrunner among investment options. And over a duration of three years and above, debt mutual funds are more tax efficient due to indexation benefits. Indexation helps an investor to adjust inflation while calculating the long-term capital gains, which lowers the taxable income.

Short and long-term goals
However, it’s essential to tag your investments to a short or long-term goal. You don’t want to invest the money you need for your short-term needs in a long-term mutual fund that you’re using to build wealth.

Within debt funds too, there is a category that could be considered to help achieve your short-term goals—liquid funds. They are a class of debt funds that majorly invest in short-term fixed interest generating money market instruments like commercial papers, treasury bills, etc., with a maturity not exceeding 91 days. Now, having said all that, you should also know the risks associated with these types of investments.

Risks with mutual funds
Market risk: It simply means the risk which may cause losses for an investor due to the poor performance of the market.

Concentration risk: This means the underlying portfolio has too much exposure to a particular instrument or securities and fails to diversify.
Interest rate risk: The returns earned from debt funds are inversely proportional to the interest rates prevailing in the economy. An increase in the interest rates during the investment period may result in a reduction of the price of securities.

Credit risk: It is the risk that the issuer of the scheme may be unable to pay the promised interest. So, always check the credit ratings. An AAA rating is the ‘highest’ rating and C is a low credit rating, resulting in credit rating downgrades and fall in NAV. A fall in rating may be due to the deteriorating financial/governance profile of the firm in which the fund is invested, resulting in credit rating downgrades .

Liquidity risk: Liquidity risk refers to the inability to liquidate an asset at the desired price. Liquidity risk can occur due to demand and supply conditions, rise in interest rates, change in the credit rating of the underlying instrument. The best way to avoid this is to go for a diverse portfolio and select the fund carefully. Invest in a diversified portfolio that comprises equity, debt and gold asset classes.

The writer is vice-president, Customer Interaction, Quantum Mutual Fund

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