There are multiple investment options available these days and often, selecting the right one perplexes many investors. From investing in real estate to stocks to term deposits and much more, investors have to choose the right type of investment for them depending upon their expected rate of return, their risk profile and the period of investment. The biggest factor among these is typically risk since investors often naturally prefer low-risk investments, all other factors being nearly equal.
Mutual funds have become popular lately, as they provide flexibility to investors on each of these factors i.e. the expected return, risk profile and the period of investment. However, the risk factor in mutual funds is significantly lower, relatively speaking, amongst all the other investment options, considering the high returns it provides. The Sharpe ratio i.e. the average return earned in excess of the risk-free rate for every unit of volatility or standard deviation is the best among most of the other investments for mutual funds.
Here are 5 reasons why the risk is fairly low while investing in mutual funds:
1. Diversification
- Mutual Funds are categorized into multiple segments, of which Equity, Debt and Hybrid are the most popular categories.
- Equity Mutual Funds invest a majority of their assets into equity stocks, while debt funds invest in fixed income instruments. Hybrid funds invest in both equity stocks as well as debt instruments.
- During situations of high volatility in the market or during the bear market, investors can move to hybrid funds to protect their capital, since hybrid mutual funds shift their assets from equity to debt thereby reducing the risk of the downside and achieving optimal returns.
- An investor can always on his own transfer his investments into debt funds from equity funds to minimize the risk factor. This diversification in Mutual Funds makes it a less risky option.
2. Wide range of the portfolio
- Equity oriented funds typically invest in the equities of a wide range of companies. Multiple equity stocks significantly lower the standard deviation of the portfolio thereby reducing the risk factor as well.
- For example, the Mid Cap fund of Birla Sun Life Mutual Fund invests its assets in at least 54 equity stocks of mid-cap companies, which trade in the stock exchanges. This reduces its volatility as compared to funds with the lower range of stock holdings. Hence, wider the range of portfolio, closer would be its standard deviation to the major indices of stock exchanges. Investors can know more regarding the Birla sun life mutual fund by visiting several mutual funds websites.
3. Professional fund managers
- Mutual Funds are managed by professional fund managers appointed by the fund houses and are highly qualified. Fund managers with their experience and in-depth knowledge can manage the funds far more efficiently than an average investor who manages his own portfolio.
- Additionally, fund managers can analyse the peaks and troughs of the market which helps in limiting risk exposure.
- With a minimal percentage of the capital as a fees/commission to the fund managers, investors get to avail the services of experts in managing their investments.
- For example, Chirag Setalvad of HDFC Mutual Fund handles various categories of funds and has been consistent in achieving more returns than the industry.
4. Bias in personal judgement
- The average investor typically tries to time the markets in all types of assets. For example, most investors get attracted to real estate when the prices fall or when the real estate market is on the verge of recovering.
- It is a similar case with the equity markets as well, wherein the retail investors look for underpriced stocks or stocks with a reduced price.
- But personal judgement and predictions can prove costly as a formerly beaten-down stock can sink in further and the investors ultimately get trapped in such stocks or have to bear heavy losses.
- In mutual funds, systematic withdrawal planning (SWP) assists in preventing the investors from trying to time the markets too much; whereas SIPs generally help in averaging the cost of investment.
5. Sectoral investments
- There are certain categories of equity mutual funds which solely invest in the stocks of an industry or sector. If an investor holds a positive outlook over a sector, he could invest in that sector’s mutual funds. In such funds, diversified stocks help to spread the risk, unlike investing directly into individual stocks or assets.
- Another category which is similar to the sectoral fund is the thematic fund, wherein the funds buy and hold the equity stocks of the companies following a common theme.
You’re going to have to deal with risk is a majority of investments, but mutual funds provide a very different level playing field for investors, where the returns are generally high compared to the risk they come with. This makes mutual funds a very attractive investment option among the masses.
