Understanding Risk and Return in Mutual Fund Investing

Successful investment in mutual funds requires a fundamental understanding of the dynamic balance between risk and return. When you start your adventure into the world of mutual funds, you join a financial environment where the market’s inherent uncertainties counterbalance the potential for gain.

In this intricate tango between risk and reward, investors must tread carefully if they want to make choices that align with their financial goals and risk tolerance. This article will examine the fundamental ideas of risk and return in mutual fund investing, illuminating the variables and how they affect your investment plan.

Mutual Fund Investing – How to Measure its Performance

Mutual fund investing can be fascinating because it includes investing your money in various securities, including equities and bonds. Hence, understanding how its performance is measured is crucial. Although you can use a mutual fund return calculator, understanding the logic and concept behind it makes the difference.

When considering the fund’s performance, do not just go with the returns in isolation. There could be an instance where the fund has delivered good returns in the last couple of years, directly correlating to the growing market. If the scheme’s NAV declines more than its benchmark, you should reassess your investment if it underperforms in a bear market.

Therefore, investors should use the fund’s performance and measure it against the industry benchmark. Additionally, It is advisable to eliminate investments from one’s portfolio that consistently fall short of their expected performance over time. Over a longer time horizon, it’s critical to discover underperformers and outperformers.

Moreover, an investor should also evaluate – category average returns. It is because if the fund has overperformed its benchmarks, other funds may be outperforming in the same group. Therefore, the category average returns will determine the investment’s good or bad against the others in the same group. It can help decide whether to stick to the asset or move on to others.

Therefore, using a mutual fund return calculator while measuring performance and before investing in a specific fund is always recommended.

When Should You Review Your Investments?

One mistake investors make is reviewing their investment performance every time the market rises or falls. If you want your funds to perform and give returns, you should wait at least 18 to 24 months.

In addition, you can list all your funds that are already underperforming than the benchmark. These funds can be reviewed every 2-3 quarters, and the performance can be gauged against the others. If the performance does not improve, you can plan on changing or moving your investments.

Also Read: 10 Questions to Ask Before Buying Group Term Life Insurance Plan

Risks in Mutual Fund Investing

Here are some of the common risks involved with mutual fund investing.

1. Returns Not Guaranteed

Although the thumb rule is always to use a mutual fund return calculator to determine whether you are investing in the suitable scheme, there can still be instances when you may not get the expected returns. There can be several reasons behind this; hence, people should invest after considering every element.

2. Market Risk

A portion of market risk will always be present when purchasing any financial item. Moreover, a mutual fund is always prone to changing market conditions. These could be because of global or national economic unrest, changes in government policies, laws, and regulations, or any natural disasters.

3. Specific Security Risk

Numerous unique threats concern specific securities. Examples include the potential for a corporation to fail to make a principal and coupon payment on its debentures, as well as the consequences of a decline in a company’s credit rating. All of these also impact the overall returns of the fund. Thus, it can affect the investor’s portfolio.

4. Liquidity Risk

Liquidity risk is the likelihood that an asset may be quickly sold for at least its fair value based on the amount of transactions in the market. As a result, depending on the circumstances, investors should be ready to sell their assets for a discount.

5. Inflation Risk

Like liquidity risk, investors should be aware of inflation risks as well. When the purchasing power of the investment goes down because of a general increase in consumer pricing, it is known as inflation risk.

6. Financing Risk

At times, investors take loans to invest in mutual funds. If a loan or financing is done, there are multiple elements that they should be aware of. Borrowing money increases the likelihood of both profit and loss.

Additionally, suppose the investment value falls below a predetermined threshold. In that case, investors may be asked by the financial institution to increase the collateral or decrease the current loan amount to the minimum level.

The interest rate will also affect how much borrowing will cost. Therefore, a potential investor should carefully analyse each consideration before selecting a loan to invest in mutual funds.

7. Compliance Risk

Like a fund must comply with several rules and regulations imposed by the government, an investor and their manager must adhere to them. If either cannot comply with the laws and regulations, fines and penalties can be attached. Such instances can lower the returns that were initially expected.

8. Manager’s Risk

The portfolio manager is another element that can make or break the portfolio in addition to those already discussed. The investment could be rewarded significantly if the management is skilled and educated about how and where to invest. However, if it’s not, there can be significant losses because of the same.

Conclusion

Understanding the delicate balancing act between risk and return in the complex world of mutual fund investing is not simply a helpful ability but a tactical need. Investors are guided through the constantly shifting financial market environment by the link between the two.

Investors can adjust their investing strategies to fit their financial objectives, level of risk tolerance, and time horizon by having this information.

A well-informed approach to risk and return can lead the way for a more secure and profitable financial future in the dynamic world of mutual funds, where opportunities and difficulties abound.