Risky Mutual Funds that you must avoid as a Smart Investor
You must have seen all these advertisements where a man’s voice tells you about the risks associated with mutual funds in a rather incomprehensible manner. But if you are one of the people who are thinking of mutual funds investment lately, then you need to know about all risks associated with it. There are also some risky mutual funds that you should avoid. In this blog, we will dissect this seemingly complex topic of mutual funds.
Mutual funds are an investment vehicle in which many investors pool their money to earn interest on their capital. The interest is earned when this pool of money is divided and invested in multiple ventures such as bonds, stocks, gold, and other assets.
This task is carried out by a fund manager or portfolio manager who manages the entire corpus of funds. But the gains or losses on any of these mutual funds are borne by all the investors in terms of the proportion of their investment.
The fact that the money is invested in all these different ventures and all of them are prone to fluctuations based on several factors of the market makes mutual funds risky. All investors in mutual funds are prone to losses but the risks can be mitigated by identifying the risky mutual funds beforehand.
But how risky mutual funds are? Well, that depends on the amount of investment and the expected returns. The greater the return expected, the more will be risks associated with it.
Depending on the mutual fund objective and category, it can be associated with the following risks which can impact its overall performance:
- Market Risks
- Credit Risks
- Interest Rate Risks
- Liquidity Risks
- Inflation risks
That is why it is important to read all documents carefully before investing in mutual funds. But there are some more risky mutual funds that are to be avoided at all costs. I am going to tell you about some of these risky mutual funds one by one. Continue reading to find out more.
Balanced Hybrid Mutual funds
Hybrid mutual funds are a combination of equity and debt investments targeted at different types of investors. A balanced Hybrid Mutual Funds should invest its asset of equity or debt in the ratio of 40:60. The risk in hybrid mutual funds investment is proportionate to the size of asset allocation in their portfolio. So, it is important to analyze the portfolio of the Hybrid Mutual Funds to become aware of the risks involved. This scheme is regarded as a debt scheme for taxation purposes.
Fund of Funds
Funds of funds are risky mutual funds that use their pool of resources to invest in other mutual funds due to which the expense ratio to manage them is higher than the standard mutual funds. Choosing the right asset to invest in remains a difficult option as the market keeps fluctuating. The asset management company deduces this expense from the annual returns generated. It is only during the redemption of the principal amount that an investor has to pay taxes on a fund of funds.
Sector Mutual Funds
Sector Mutual funds often called Sectoral funds, are used to invest in some best-performing stocks of particular sectors such as Energy, Infrastructure, Utilities, etc. Since the portfolio is very less diversified in sectoral funds, so they are considered higher risky mutual funds.
Small Cap Funds
One should only make an investment in these risky mutual funds if one can handle the volatile price changes of the market. These are risky because a major part of your investible amount is invested in the equity of equity-related instruments of small-cap companies. Small-cap companies are those which rank below 250th in terms of market capitalization or have a market valuation of less than 500 crore rupees, according to SEBI. Although these are great opportunity for investors who are willing to take risks and wants aggressive growth but when the market condition is not good, then you can also suffer great losses.
Credit Risks Mutual Funds
These are highly risky mutual funds as they invest in low-credit quality debt securities. Hence you should be very careful and consider all factors before investing in them.
Long Duration Funds
These funds must invest in debt securities having a minimum maturity of seven years. Long-term paper costs are more susceptible to changes in interest rates. As a result, when interest rates rise, the bond values held by these funds decline, which causes a negative NAV.
This is what we are now seeing. The category average return of Long Duration funds has decreased by about 2% year to date due to the Reserve Bank of India’s (RBI) increase in interest rates this year (January to July).
These funds have also produced double-digit returns when interest rates have fallen, but they will likely be struck harder when the interest rate cycle changes than funds that are invested in shorter-duration papers will be.
As a result, timing the entry and exit from these funds is necessary, which may be difficult for individual investors to do. It is therefore preferable to stay away from money in this category if you are unable to achieve it.
Some Parting Thoughts
You should take into consideration all relevant factors and your financial objectives before making an investment in mutual funds as they are not a suitable investment option for everyone.
My advice to the readers will be to do thorough research before investing in mutual funds otherwise they can end up with losses.
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