6 Ways to Reduce Mutual Fund Investment Risk

Risk and reward are two sides of the same coin when it comes to investing. The usual mindset is that to earn higher returns, one needs to take high risks. However, unfortunately, the vice versa doesn’t hold – taking a high risk doesn’t necessarily give you high returns. Taking high risk is not a bad thing, but employing tricks that can help mitigate investment risk is necessary.

Design and Align portfolio with risk appetite

Mutual Fund investments are made based on investors’ profiles. Risk varies among investors. What is a good fund for one person might not be the best for another person? While choosing a fund one has to consider their age, financial position, number of dependents, the duration of the goal, and risk tolerance. For instance, if an investor has a moderate to high-risk appetite and has a long-term investment horizon, then equities would be the best-suited fund. While for a low-risk appetite investor, debt funds would be the best-suited category. Therefore, do not invest based on word-of-mouth recommendations, make sure you are aligning the funds with your risk appetite.

SIP Investing for all your regular savings

Be it any market phase, investing through SIP is always beneficial. SIPs keep you a disciplined investor and are very easy to monitor. It takes advantage of rupee cost averaging. Without worrying about timing the market, SIPs help in averaging the cost over time. More units are bought for the same amount when the prices are low and fewer units when the prices are high. Therefore, it is advised to invest in Mutual Funds through SIPs and not worry about overvalued markets.

STPs for Lump Sum Investments

Rather than worrying about overpriced markets while investing lump-sum amounts, a systematic transfer plan (STP) is the best option available. Similar to SIPs, STPs also take advantage of rupee cost averaging. By averaging out the buying cost, investors can relax about overvalued markets. STP is also useful when your long-term financial goals are nearing maturity. Shifting the funds from equity to ultra short-term debt funds will help in consolidating gains by reducing the downside risk.

Keep an eye on NFOs

New Fund Offer (NFO) is similar to an Initial Public Offer (IPO), where the fund is open for subscription for the first time. Since NFOs do not have a past track record, it’s challenging to analyze their performance. Therefore, in such instances, the track record of the fund managers is of utmost importance. Try to probe other funds that are managed by the fund manager and under their performance trajectory. Also, NFOs should be purchased only if your investment objective is in line with that of the fund’s strategy. They are highly risky, and hence, only if you have a high-risk appetite, NFOs are suggested. In the case of thematic NFOs, only if you are well aware of the theme or sector of the fund then invest. Otherwise, stick to the funds with a good track record.

Asset Allocation

The key to asset allocation is to balance risk and reward. Asset allocation involves investing in various asset classes like equities, mutual funds, debts, real estate, and gold. One should choose the right assets based on their financial goals. The duration of your goal will help in deciding on the asset class. For short-term goals, debt funds are ideal. While for long-term goals equities are ideal. Therefore, based on the duration and your risk appetite, the right asset class should be chosen for investment.

Diversify your portfolio

As the saying goes, do not put all eggs in one basket, do not have all your investments in the same asset class and also in the same instrument of an asset class. A common practice has been to invest in a fund that has been performing well in the near past. It ultimately increases market risk. In case the market falls, and your investment in the fund is negatively affected, you are at risk of losing most of your money. Therefore, it is always advised to have exposure to multiple asset classes and also various sectors or types in the same asset class. It helps in lowering the concentration of risk. If anyone’s fund underperforms, there is always another fund that will make up for the loss.