Risk

Risk

Mutual funds are investment vehicles that pool money from various investors and invest it in a diversified portfolio of assets such as stocks, bonds, and other securities. While mutual funds offer investors the benefit of diversification, they also come with risks. The risk under mutual funds is the possibility of losing money on the investment. As with any investment, mutual funds carry various risks that investors must consider before investing.

One of the most common risks associated with mutual funds is market risk. Market risk is the risk of a decline in the overall market value of the assets held by the mutual fund. This risk arises due to fluctuations in the market value of the underlying securities, which could result in a decline in the net asset value (NAV) of the mutual fund. Market risk is inherent in any investment that involves exposure to the stock market or other securities markets.

Another risk associated with mutual funds is credit risk. Credit risk is the risk of a borrower defaulting on its debt obligations. Mutual funds that invest in bonds and other debt securities are exposed to credit risk, which can lead to a decline in the value of the mutual fund. The creditworthiness of the issuers of the bonds held by the mutual fund is a key factor in determining credit risk. Finally, liquidity risk is another risk associated with mutual funds. Liquidity risk is the risk that the mutual fund may not be able to meet redemption requests from investors due to a lack of cash or liquid assets. This risk is more prevalent in mutual funds that invest in illiquid assets such as real estate, private equity, or venture capital. Investors should carefully consider the liquidity risk associated with a mutual fund before investing.

To assess the risk involved in a fund, one should look at how much its returns change from one year to the other. If there is too much variation in the year-to-year returns, it may be considered higher risk because its performance can change rapidly in either direction.

For instance, if a fund losses 5% in 2009, gains 17% in 2010 and gains 2% in 2011, it is possibly riskier than a fund that gained 6% in each of the past three years. In investing, the higher the potential return, the higher the potential risk. With higher expectation of returns, one must also be prepared for the risks involved.