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Mutual Funds Are Subject To Market Risk Things to Know Before Taking This Risk

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  | Published: 25 January 2020 | Last Updated On: 19 January 2021

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Whether you are an investor who is just beginning his/her investment journey or you are an investor who has been on this journey for quite some time, you are probably aware of the fact that there are thousands of mutual funds to choose from and numerous details to know.

However, the few basic things that an investor should consider before moving forward to invest in mutual funds.

Investing With Mutual Funds

Why an investor wishes to invest in mutual funds is because he/she wishes to save money and to earn returns on those savings that are potentially higher than those offered on guaranteed investments such as CDs. However, it is essential to first have clearly defined investment objectives and time horizon that you have to invest. This helps in choosing the best mutual funds for your financial purposes. In general, mutual funds are best used for longer time horizons, such as more than three or preferably more than ten years.

The Risk Involved

The main reason behind the fact that mutual funds provide greater returns over the course of time than the returns offered on guaranteed investments is because of the risk premium that is rewarded to the investors. This premium is provided in the form of higher returns associated with the investor accepting market risk. This risk is the risk of losing either some portion or the entire amount that one will invest.

One of the greater risks for you as an individual investor is you yourself! You should be careful of chasing performance when it comes to the decision to invest in these funds. This is the human tendency to continuously buy the funds that are the top performers and sell those funds that are not performing that well. What you need to keep in mind is that when you invest, you should not seek the thrill. It is supposed to be boring and you require a lot of patience in order to achieve the desired returns in order to fulfill your financial objectives.

Diversification of Buying Baskets

Mutual funds represent a basket of various investments because via a single mutual fund the investor can invest in multiple, say dozens or even hundreds of securities (stocks, bonds, or both). Many mutual funds in the market are there which are diverse enough even alone to invest a large percentage of your savings. However, it is always a good idea to spread your risk by diversifying your savings across the different mutual funds available in the market such as bond funds, money market funds, and stock funds.

Know the Expenses and Loads

There are various costs associated with the process of buying and selling mutual funds. These costs can be divided into four general types: front load, back load, no load, and expense ratio.

  1. Front Load: These costs are charged upfront and the percentage charged varies.
  2. Back Load: These are the charges involved when you sell a fund. They are also known as deferred sales charges.
  3. No Load: This expense category of mutual funds does not involve any front load or back load.
  4. Expense Ratio: Not all types of funds charge a load, however, there is a certain underlying expense in all types of mutual funds.

The Past Does Not Define the Future

We have all heard those disclaimers about the past performance of mutual funds. However, an investor seeking to invest in mutual funds will still consider the past performance of a fund in the initial evaluation before buying it. What you should focus on is to review past performances of a longer period, say 5 or 10 years, and compare this performance against the other funds falling under the same category. Another thing that is very important is to see how long the fund manager has been in the control of that fund. For instance, you find a mutual fund with a great return over the course of five years, but the manager’s time at the fund (referred to as manager tenure) is only over a year, the new manager can't hold the credit for the five-year performance of the fund.

To Further Conclude

Mutual funds are a great investment instrument for the investors out there. However, the above-mentioned facts should be kept in mind before going forward to invest in them. As it is said, every investment holds some risk, which makes even mutual funds subject to market risk!