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Business News/ Money / Personal Finance/  Mutual Funds: How to identify the risks that the funds carry? An explainer
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Mutual Funds: How to identify the risks that the funds carry? An explainer

The scheme information document (SID) helps investors identify various types of risks and their possible impact on profitability.

There are six levels of risk a mutual fund undertakes: low, low to moderate, moderate, moderate to high, high, very high Premium
There are six levels of risk a mutual fund undertakes: low, low to moderate, moderate, moderate to high, high, very high

When you invest in a mutual fund, you are likely to nurture hopes of high returns in the medium to long-term. These hopes are natural for any investor but there are certain risks that one undertakes as you invest in a mutual fund scheme.

Some of the risk types that a business undertakes include credit, business, market, price and liquidity.

The scheme information document (SID) helps investors identify the various kinds of risks and their possible impact on the scheme's profitability. This is why prospective investors are recommended to peruse the SID carefully.

As far as the levels of risk is concerned, the market regulator has given instructions to share a risk-o-metre with six levels of risks: low, low to moderate, moderate, moderate to high, high, very high.

Mutual fund riskometer is made on the lines of a car dashboard where the needle moves clockwise as the speed rises.
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Mutual fund riskometer is made on the lines of a car dashboard where the needle moves clockwise as the speed rises.

Based on the level of risk, investors can recalibrate their expectations accordingly. However, the risk-o-metre gives a general sense of the risks that a mutual fund undertakes. In order to understand the risks more accurately, one can see the fact sheet for the following details:

Standard deviation: This shows the range of returns given by a fund. This effectively means higher the standard deviation, higher the risk which the fund carries.

Beta ratio: This shows the fund's volatility with respect to the market. A beta of more than 1 indicates the fund will be more volatile than the market. On the contrary, a beta of lower than ‘1’ shows the fund has a lower volatility than the market. And a beta of 1 means the fund will move in alignment with the market.

Sharpe ratio: It shows the excess returns per unit of risk undertaken. This gives the idea of risk-adjusted returns on the mutual fund investment.

Now that we know that investors have to undergo some element of risk when they invest in a mutual fund scheme, it is important to know how the risk can be contained.

There are two ways to minimise the risk:

Firstly, the undisputed way to manage risk is diversification of assets. This means by investing in an array of assets, you can hedge your bets and rely on safer assets during a time when the other assets turn riskier.

Second is to seek professional help. When in doubt, you can approach a Sebi-registered investment advisor (RIA). The advice of a professional advisor can help you sail through the risky waters that you face during your investing journey.

sip-calc-widget
A diversified portfolio neatly divides your assets into more than one asset class in order to reduce risk and maximize profits.
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A diversified portfolio neatly divides your assets into more than one asset class in order to reduce risk and maximize profits.

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Published: 16 Sep 2023, 12:14 PM IST
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