Why Mutual Funds Are Subject To Market Risk?

baljitsinghAugust 3, 2021

1,494 3 minutes read

The fundamental (funds) investment basics are to make profits, and everyone assumes that is all that happens. However, there are lots of risks that come with investing that many investors shy away from.

Although mutual funds offer better diversification to investors, it is also associated with few risks. The reason mutual funds are risky is the fact that funds are put in a variety of investment instruments. These include debt, equity, corporate bonds, and many more. Mutual fund investments are subjected to loss because the price of these investment instruments fluctuates due to many factors. However, mutual fund investors can avoid these by identifying the risk involved in mutual funds beforehand. Let’s dive into some of these risks.

What Are Market Risks?

Market risk is defined as a possibility that the investment market will decline, causing investments to lose value. It does not matter if investors do everything right and companies do not alter their operations. Market risk is the risk obtained from all types of investments. It is often the result of the volatile nature of the market and the general global economy. Market risk is an unpredicted or unexpected outcome.

For example, when investors buy an investment, they expect the prices to go up to earn profits when they sell it. However, the price of the investment might fall more than expected after they purchase it. This is known as market risk. Many campaigns have succeeded in attracting people to buy mutual funds. However, it has misled them into thinking there are no risks involved; these make them ignore the statutory warning.

Mutual Funds Market Risk

Political Instability

One of the biggest mutual fund market risks is political instability. When the Central Government is unstable, it often harms the market. It also leads to economic paralysis, stagnancy, and a slow down in the country’s Gross Domestic Product (GDP) growth. These lead to a total fall in the mutual market. Therefore, government stability, reform agenda by the government are important factors in the mutual fund market stability.

Liquidity Risk

Liquidity risk emerges when an investor does not find a buyer for their security. This implies the investor is struggling to redeem an investment without incurring a loss in the value of the instrument. For example, Exchange-traded Funds can suffer from liquidity risk.

This is because Exchange-traded Funds can be bought and sold on the stock exchanges like shares. But sometimes investors are unable to redeem their investment when they need it the most because there are no buyers in the market. Therefore, the best way to avoid this is by having portfolio diversification and also select your funds diligently.

Increased Commodity Price

When commodities such as crude oil, diamond, gold, and others increase, it affects individual and corporate consumers of these commodities. For example, most of these commodities such as crude oil are imported to India.

Hence, when the price increases it puts pressure on the country’s current account deficit, foreign debt, and many more. These can destabilize the country’s balance of payment which affects the capital markets leading to capital markets collapsing.

Also, Read – What Personalized Apparel Boxes Do For Businesses?

Foreign Fund Outflows

The Indian capital markets and other economies greatly depend on foreign fund inflows. Therefore, a negative turnaround of the foreign fund flows out of the economy impacts the capital markets. It can also cause a big connection in the other markets.

Credit Risk

Credit risk is a default on a debt due to a borrower’s failure to pay what was promised as interest. Agents handling investments in the mutual market are often with these criteria. This shows investors firms that will pay high and vice versa. Credit risk also affects mutual funds. The fund manager has to include only investment-grade securities. But sometimes lower credit-rated securities might be incorporated into the fund to earn a higher return. This helps in increasing the credit risk of the investor’s portfolio. Hence, it is important to always check the refit ratings of the portfolio composition before investing in the mutual fund.

Interest Rate Risk

High-interest rates are a big risk for the mutual market and often lead to market fall. Many stock markets across the globe often fall when there is a high-interest rate. The Stock markets usually do well when there is a low interest rate. This is because It allows many companies to borrow at lower interest rates and then invest in business expansion. This helps them to earn higher profits. The market grows when many companies are making profits.

The Bottom Line We all know mutual fund investments are subjected to risk. But you will lose out on earning good returns in the long run if you don’t invest in mutual funds because of these risks. The risks can also be addressed with appropriate asset allocation, proper fund diversification, and discipline.