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How do mutual funds balance risk with equity investments?

By Finserv MARKETS - Aug 2,2019
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How do mutual funds balance risk with equity investments

While thinking about investments, it is imperative to consider the risk factors. The idea that ‘risk and reward’ go hand in hand or ‘more risk, more gain’ might not always be true. When it comes to investments, taking too much risk will not necessarily give you the expected returns. Thus, it becomes important to understand the different kinds of risks that you will be exposed to and, second, to analyse how much risk you can tolerate and if it would be wiser to avoid taking it altogether.

This is specifically relevant for equity investments as there are a number of risk factors associated with this kind of investment. Financial investment in equity might seem like a lucrative option, but one must consider some obvious factors in mind before venturing. To be a player in the stock market, it is important to have significant knowledge about each and every aspect: how the market works, market cycles, issues and problems, and how you should react under unstable conditions. The stock market is difficult to understand and predict in general.

Mutual funds, on the other hand, fills up certain gaps and are, comparatively, a safer option. According to the Association of Mutual Funds in India (AMFI), the Assets Under Management (AUM) of the mutual fund industry rose from Rs 21.26 trillion in 2017, December to Rs 24 trillion in 2018, November; rising by almost 13 per cent. Investment in equity mutual funds through Systematic Investment Plan (SIPs) has given an average return of 10.26 per cent in the last five years.

How do mutual funds balance risk with equity investments

This can be understood on the basis of three prominent advantages that you get when you invest in mutual funds:

Diversified investments

Through mutual funds, your investments are diversified. These are pooled investments and unlike equity investments, you get to invest in different firms and sectors. This spreads your market risk because you hold a number of stocks rather than just one and also with a single portfolio.

The reason why this is considered the biggest advantage that mutual fund investments offer is because investment in one or two securities comes with a lot of risk, like equity investments. For example, you buy three or four stocks and the market happens to be down, then this will impact your portfolio by bringing the value of your stocks down. But if you have invested in, say for example, in 20 securities then even if there is a decline in value of a few of them, the impact won’t be that significant.

Ten years back, the trend was to invest in direct equity investments. In FY18, more and more investors started opting for the systematic investment plans (SIPs) . The direct retail holding in the BSE 500 index stocks dropped to 11.7 per cent in March 2018 from 13.1 per cent in March 2014, while the equity assets under management of mutual funds increased four times in this period.

Liquidity

Although mutual funds are ideally meant for long-term investments, you can easily move your money and exit a plan. This is an added advantage as your money is not stuck and, in case of an emergency, you can rely on this investment.

Professional managers

Mutual funds are handled by professional managers who have significant knowledge of the market. They will take decisions on your behalf regarding the sectors and firms where the investment should be made and they will also decide on the time period of a particular stock in a particular firm or sector.

The overall performance of a firm and the sector will largely determine the value of your stock. A professional will have a better understanding than a retail investor about where to invest to get higher returns even during unstable market conditions. Mutual funds are excellent options for beginners and those who have little knowledge of the market. These investments are quite transparent as the companies come under the purview of SEBI and disclosures are mandatory.

You must, however, keep in mind that mutual fund returns also vary and to an extent depends on the prevailing market circumstances. You need to have a realistic approach while calculating your returns.

Now that you are aware of the pros and cons of mutual funds, consider purchasing them on Finserv MARKETS. Finserv MARKETS is an online platform that gives you a fast, transparent online buying process for a wide variety of mutual funds. There is no commission and you will receive detailed portfolio insights, allowing you to effectively control your portfolio.

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