Mutual Funds: Six steps to reduce your investment risk

Mutual fund, Mutual fund investment, investment risk, MF investment risk, financial position

As investment in mutual funds comprise varying degrees of risk, you must factor in your financial position, age and expected income growth in near future to assess your risk appetite.

Your investments can customarily be summarised in two words—risk and reward. The thumb rule is greater the prospective reward, greater is the risk. However, the rule is not true in reverse order—higher risk does not necessarily mean higher potential reward, unless you know the tricks to mitigate the risk. Here are some strategies that can help you manage your mutual fund investment risk.

Align portfolio with risk appetite

As investment in mutual funds comprise varying degrees of risk, you must factor in your financial position, age and expected income growth in near future to assess your risk appetite. Tailor your investment portfolio based on your risk tolerance level. For instance, investors with moderate to high risk appetite would invest largely in equities to achieve their long-term goals. On the contrary, low risk appetite investors prefer balanced portfolio, which would involve a mix of both debt and equity, even for their long-term financial goals.

Know when to invest in NFOs

New Fund Offers (NFOs) are the first-time subscription offer for any new mutual fund offered by AMCs to the public. They are available at face value of Rs 10 per unit during the offer period. However, many distributors wrongly upsell NFOs by citing their lower NAVs. Given that NFOs do not have past track record for comparing them with peer funds and benchmark indices, you must factor in past track record of other schemes managed by the fund manager and fund house. Opt for a particular NFO only if it comes with unique offerings that suit your risk appetite and financial goals.

In case of sector/thematic NFOs, higher risk appetite investors with the ability to track the concerned sector/theme and time their investments should go for them. Otherwise, you are better off investing in existing mutual fund schemes having a good past track record.

Invest through SIP

In a systematic investment plan (SIP) a pre-determined amount is invested in selected schemes at regular frequencies regardless of the current NAV or market level. SIP includes the concept of rupee cost averaging, which averages out the cost at which investors purchase units over time with zero need to time investments and monitor the market. More units are bought when market prices are low and lesser units are bought when the prices are high.

Invest lumpsum surplus via STP

The process to automatically transfer from one mutual fund to another happens via systematic transfer plan (STP) at periodical intervals. Like SIP, STP assists to spread out the investments over the time-period to average the buying cost and rule out risk of getting into over-valued markets. STP can also be used to reduce the market risk as you reach the maturity of your long-term financial goals. Shifting from equities to low risk ultra-short duration debt funds will allow you to consolidate your gains while reducing the downside risk.

Consider asset allocation strategy

Asset allocation refers to the process of diversifying your investments across various asset classes like debt, equities, cash equivalents etc. The objective is to balance your portfolio’s rewards and risk according to your risk appetite and time horizon of financial goals. As equity mutual funds can be highly volatile in short term, investors should consider investing in short term debt funds for financial goals maturing in 36 months due to their capital protection and higher income certainty features.

Build a diversified portfolio

Often, investors put their whole investible surplus in only one scheme, sector/ theme that delivered them good returns in near past. However, doing this concentrates the market risk in only one sector/ theme or fund management team. Unfortunately, if your chosen sector/ theme undergoes adverse market condition or fund management of your selected scheme takes incorrect investment call, your investments may underperform broader market for a long time-period. Instead of placing all your hopes on one investment theme or fund type, diversify your investments across different funds to lower the concentration risk. If any one fund underperforms, the other funds in your portfolio will make up for the loss.