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Is It Safe to Invest in Mutual Funds?

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Risks in Mutual Funds

Every mutual fund offer document, and all publicity material, contain the statement – “mutual fund investments are subject to market risks.  Please read the offer document carefully before investing.” There is no denying the fact that mutual fund investments are exposed to risk, but risk is inherent in nearly every human activity. Every day accidents occur on the roads but that does not mean that people do not drive cars or walk on the street. Investors need to guard against taking unwarranted and unacceptable risks.

Product Labeling

One of the responsibilities of the Securities and Exchange Board of India (SEBI) is investor protection. Regulation of mutual fund investments is in the purview of SEBI which has made colour coding mandatory for all mutual fund offer documents.

Blue Colour indicates low risk investments that include liquid funds, fixed maturity plans, gilt funds, and debt mutual funds, in general. These schemes are suitable for investors who wish to expose themselves to only limited risk.

Yellow Colour conveys the presence of moderate risk. Hybrid funds, balanced advantaged funds, monthly income plans, etc. would be included in this category.

Brown colour indicates that the investment is high risk. All equity fund schemes whether large cap, small cap, mid cap, diversified, etc. fall in this category. These schemes are suitable for investors who have a large risk appetite or have the financial strength to stay invested for the duration of an intervening down side, if any, and exit when the market and the NAV of the fund recover.

This transparency in the offer document is intended to mitigate the risks of investing in mutual funds.

Returns

No mutual fund can guarantee returns or safety of your investment. Theoretically, you could suffer erosion or loss of your investment. But, practically, this is a highly unlikely scenario. In the short term it is possible that your investment may exhibit loss. But, over a long period the investment will most probably gain in value. The table below reveals the actual results of investment in a mutual fund.

Period of investment Amount (Rs.) invested Market Value (Rs.) Return (%)
January 2016 to March 2016 30,000 29,768.85 -6.52
January 2012 to March 2016 5,10,000 6,51,163.86 11.77

The table reveals that, over the short term from January 2016 to March 2016, the investment generated a negative return of 6.52% and the investment market value is lower than the amount invested. But, the long term picture is brighter. Over a 4 years period, the investment return is 11.77%. You could check this for nearly any equity fund and the picture is likely to be similar especially because of the weak stock market sentiment for the last year.

Returns are intrinsically linked to the extent of risk. There is a directly proportional relationship between risk and reward – the higher the risk, the higher the reward/loss. The degree of risk is a call that the investor has to make.

Legal Framework

Mutual funds are registered under the Indian Trusts Act, 1882. The fund is established by a sponsor or a group of sponsors. The sponsors, who are well established entities in the financial sector, appoint an Asset Management Company to manage the schemes. Mutual funds have to adhere to the regulations laid down by SEBI and the investors are assured of transparency and robust governance standards in the management, marketing and accounting of the funds.

There is an element of risk in mutual fund investments but fundamentally, it is safer to invest in mutual funds rather than to engage in direct stock market plays.

Note

The illustration is based on the returns from the ICICI Prudential Focused Chip Equity Fund Growth.

(This article provides general advice and recommendations and does not constitute personal advice. The selection of funds was made at random. While the calculations are accurate for the period to which they refer, the opinions and examples in this article are for informational and educational purposes only. The statements in this article should not be construed as advice to invest in the funds named. Mutual fund investments are subject to market risks. Investors are advised to perform personal due diligence before investment. Readers are responsible for the decisions they take.)

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Randolph Rowe is a professional banker and former General Manager of Small Industries Development Bank of India (SIDBI). He brings with him the wealth of 34 years of all-round experience in the banking sector - comprising 12 years with IDBI and 22 years with SIDBI - which he combines with his flair for writing.

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