New investors are generally looking for answers to questions like “what is a mutual fund” and “how to reduce risks when investing”? Mutual funds are considered a good investment tool, mainly because they allow an easy way to diversify your investment portfolio as well as to get expert management of your portfolio at an exceptionally low cost. But before you go ahead and invest your money, it’s a good idea to keep these factors in mind to help you manage investment-related risks in mutual funds:
#1 – Choose a Reputed Mutual Fund Company
The most important step that can help you reduce investment risks is investing in a good product offered by an established mutual fund player. This can be done by checking the track record of the mutual fund company in terms of the performance of the various schemes offered by it and the assets under its management. You should also check the holdings of a scheme to ensure that the fund is investing in stocks or instruments with sound fundamentals.
#2 – Invest in Funds that Match Your Risk Profile
Before investing in any scheme identify your risk profile. Clarity about how much risk you can bear to or are willing to take will help you compare various mutual funds based on the risk associated with them. The risk profile of a scheme is measured by the type of its investments and the associated credit risk, interest rate risk, liquidity risk and volatility in the markets. Your risk profile depends on your age, your income, the goals that you wish to achieve, and many more factors.
#3 – Explore the SIP Option
An excellent way to manage the risk associated with market-linked instruments is to invest via the Systematic Investment Planning or the SIP route. Equity mutual funds generally offer the SIP option wherein you agree to invest a fixed amount every month or quarter for a pre-defined period. This allows you to invest even a very small amount besides offering you the benefit of rupee cost averaging. This means that since you are investing the same amount at different cycles of the market, your acquisition cost gets averaged allowing you to participate in all phases of the market. This also does away with the need to time the market.
#4 – Invest in Diversified Products
A good way to handle the risk involved in market-related investments is to have a diversified portfolio. Invest a portion of your funds in equity while putting the remaining in debt or schemes investing in both. Go for exposure to different asset classes, and different sectors in one asset class to offset the risk involved in one with the safety offered by the other. So, when you are investing in equities, diversify your investments by choosing large-cap as well as mid-cap stocks. Do not put all your eggs in one basket by investing in different schemes of one mutual fund only.
#5 – Use the Systematic Transfer Plan option for lumpsum investments
Just like SIP helps you in rupee cost averaging, STP or Systematic Transfer Plan helps you in managing risk. An STP allows you to periodically shift money from one mutual fund scheme to another thereby helping you to balance the market-related risk.
#6 – Check the Long-Term Returns
Mutual funds are long-term investments and so the performance of a scheme should not be judged solely on its performance in the short term. Returns over the long run reflect the fund’s performance in all stages of the market while short-term returns are only reflective of only a short phase and thus are not realistic. By analysing a fund’s performance over the long term, you can reduce the chances of erosion in the event of a market downturn. A fund performing consistently over several years is always better than a fund providing superior results in the short run.
#7 – Invest in New Fund Offers Selectively
You may get tempted to invest in new fund offers by an asset management company in whose schemes you are already invested. But before investing do check its investment goals and ensure that they match your profile. Since there are no performance records of these new schemes you have to be careful and invest selectively.
#8 – Periodic Review of Portfolio
A periodic review of your investments and their returns will help you check whether you are on track to meet your goals and if not, you can always rectify the situation by changing your asset allocation or shifting your investment from one scheme to another scheme.
Investment in different types of mutual funds allows investors to get exposure to a variety of instruments without having to do much research about the stock markets and the economic scenario. But choosing the right scheme and investing in schemes with different investment portfolios and goals is essential for managing the risk involved.