There are many benefits to investing in mutual funds. Many investors see them as convenient and effective means to invest. However, just like any other investment product, mutual funds are not without risk.
The risk is unavoidable and can vary from scheme to scheme, and while that is the case, there are a few things you can do to mitigate the overall risk associated with investing in mutual funds.
Mutual funds can offer instant diversification to an investor’s portfolio, making it a popular investment vehicle today. However, the diversification can vary, depending on the scheme. Schemes with the most allocation to equity and debt often provide excellent room for diversification.
Every type of mutual fund scheme (equity, debt, and hybrid) has different subtypes and risk levels. Therefore, when picking a scheme to include in your portfolio, you need to make sure that you will also be able to diversify across the subtypes and determine the risk associated with each subtype.
Try not to invest in funds from one fund house only, as it may result in a concentration that can be detrimental to your portfolio. Avoid making such a move by selecting schemes from more than one fund house.
Overall, to achieve optimum diversification, the technique should be applied in the schemes and their subtypes and fund houses to minimize the risk to your portfolio.
- Watch Out for Overlaps
An overlap of businesses or sectors can sometimes occur when choosing schemes, even if the investments are directed through different fund houses.
The overlap can create a concentration risk that could negatively impact the portfolio, preventing it from taking advantage of opportunities in other industries and categories, which may have added value.
So before investing, perform a thorough check of the schemes. Review the objectives, risk profile, type of scheme, and category. You also need to make sure there is no overlap in sector and category with any of the schemes that are currently in your portfolio.
- Opt for a Systematic Transfer Plan (STP)
STP is an investment strategy where an investor transfers a certain amount of money from one scheme to another, which can be from a debt fund to an equity fund. Using this technique allows investors to reduce the volatility in the equity markets. It can also deliver cost averaging.
Usually, there is uncertainty about an upcoming correction when the markets are high. So as not to keep your money in the investment at the peak or close to the peak rate, you can consider investing for at least six to nine months.
- Check Your Investments from Time to Time
Tracking and reviewing your investments help you stay updated with your portfolio’s condition and performance on your financial goals. In this process, you remove the schemes holding your portfolio back and put new ones in their place.
Still, it is crucial that you only compare the portfolio’s performance and a benchmark when deciding whether a readjustment is needed. You also have to consider the taxation and other charges associated with the change.
If possible, performing a portfolio and investment review should be done semi-annually, but if you have a long list of financial goals that you want to achieve, then regularly checking them could be an option. On the other hand, if your list is short, once a year should do it.
Keep in mind that other funds’ performances do not determine whether you should make changes in the portfolio, as the fees are high because of taxation and the winning assets are continuously rotating. Debt funds only take a short time to check, while equity funds take quite a while to assess.
- Protect Your Investment Once the Goal is Met
You can transfer your investments to a safer product if a corpus needed for your financial goals is met sooner than expected. This way, you can protect the capital you have accumulated by investing in equity.
Note that you may run the risk of losing money if you decide to stay invested in an equity fund after meeting your goal because of market volatility. That is why it is vital to move the corpus to a less risky investment vehicle than an equity-focused fund.
In the transfer process, you can choose a fund, either debt or equity, where the asset allocation between equity and debt in the portfolio is managed according to market movement, to minimize the risk.
- Consider Investing via Systematic Investment Plans (SIPs)
SIPs involve making regular or fixed amounts of payments, usually monthly, in a mutual fund. This method is ideal for investors with a long-term investment horizon.
It also works well because you can buy fewer units when the markets are up and purchase more when the markets are down. As a result, investing in equity is more manageable and a lot less stressful. With SIPs, there is less risk, and market timing is not necessary.
- Make Sure You Have Liquidity for Emergencies
While investors are generally aware of the financial risks they are taking when they take on the markets, they are also a few, not trading-related risks that can impact a portfolio’s performance.
Let’s say you need a considerable amount of money right now, but your funds have all been locked in mutual fund products, which are on their way to delivering significant returns over the long run. If you cut off your investments mid-way to cover the emergency, you would lose the potential returns.
To prevent that from happening, you can put together an emergency fund that you can use when the need calls for it without interrupting the investments intended for growth and long-term gains.
That emergency fund should be invested in schemes, preferably the ones that are unaffected by market fluctuations, as it may be called on during a market downturn. Liquid or overnight funds or floating rate funds with a quick redemption ability fits well with this requirement.
Around 5% to 10% of an investor’s entire portfolio can be offered to such schemes, while the rest of the corpus can be invested in other investment products.