Risk is an inherent part of our lives. It is almost impossible to ignore it, no matter how hard you try. But that doesn't mean you can't calibrate your risk exposure and bring it within a band you can tolerate. You can clearly define your risk appetite and use it to make better personal, professional, and financial decisions.
It is especially true when dealing with mutual funds. Defining your risk appetite before investing in a mutual fund scheme can help you make better investment choices and gauge your expected returns. Read on as we differentiate mutual fund schemes based on their risk exposure and help you figure out which mutual fund schemes are better suited for you.
What are low-risk
Low-risk investments carry low risk. They are suitable for all types of investors and provide moderate returns. Low-risk investments, therefore, offer a certain consistency and predictability to the investor. From first-time investors to those with substantial market experience, everyone can opt for a low-risk investment with an aim to stabilize their risk profile. Let us see a few examples of low-risk investments:
A debt mutual fund scheme is a comparatively low-risk investment that invests in listed or unlisted fixed-income instruments. However, it’s important to know that not all debt schemes are low risk. Some examples of fixed-income instruments are corporate bonds, government bonds, corporate debt securities, etc. These low-risk mutual fund schemes are less volatile and considered a good choice for risk-averse investors. Some debt scheme categories include: overnight fund, liquid fund, ultra-short duration fund, money market fund etc.
Liquid mutual fund schemes form a popular sub-category of debt funds. They are low-risk investments that invest in commercial papers, government securities, treasury bills, etc., with a maturity of up to 91 days.
Hybrid mutual fund schemes allocate funds to both equity, debt and other asset classes. However, the asset allocation decisions of such schemes take the market's volatility into consideration. Hybrid mutual fund schemes are therefore considered to be less risky than equity schemes as the portfolio is diversified among other asset classes as well.
What are high-risk
High-risk investments are equally important for investors. They can help investors earn higher returns by taking some more risk. Therefore, investors need to know about high-risk investments and which investments qualify as high-risk. Here are some types of high-risk investments:
Small-cap mutual fund schemes are high-risk investments that invest most of their assets into equity or equity-related instruments of companies with a small market capitalization. Small-cap schemes are ideal for investors who have a high-risk tolerance and are willing to stay invested for the long term.
Mid cap mutual fund schemes predominantly invest in equity and equity related instruments of mid cap companies. As they fall between large cap and small cap schemes they portray the qualities of both these scheme categories. Long-term investors generally prefer these mid-cap mutual funds as they offer good scope for long-term growth.
Flexi-cap mutual fund schemes are high-risk mutual fund schemes that invest in businesses belonging to the three market capitalization categories – large, mid, and small. A minimum of 65% of the total assets of flexi-cap schemes must be invested in equity and equity-related investments.
4. Credit risk fund
Credit-risk mutual fund schemes are high-risk mutual funds that invest in low-credit quality debt securities. Since credit-risk fund schemes invest in AA and below rated corporate bonds thus they are considered to be high-risk mutual fund schemes.
While large-cap mutual fund schemes carry risk, they are comparatively less volatile than medium and small-cap funds. Large-cap schemes invest their capital in companies with a large market capitalization and stable financials. These reputed companies are known for the consistent performance. Unlike the Net Asset Value (NAV) of medium and small-cap schemes, the NAV of large-cap mutual fund schemes does not fluctuate much.
Low-risk vs high-risk investments:
Based on the definition and features of low and high-risk investments, here are their differences:
Low-risk mutual fund schemes generally invest in companies with large market capitalization. High-risk mutual funds, like small-cap funds, invest in companies with low market capitalization.
Low-risk mutual funds, although safe, may grow less rapidly as compared to high-risk mutual funds.
While low-risk mutual funds may offer moderate returns to the investor, high-risk mutual funds may offer high returns.
Both low and high-risk mutual funds have their own benefits. It is up to you to decide which type of investment suits your investment goals and risk appetite. In the context of mutual funds, it is best to invest in a mix of low and high-risk mutual fund schemes to derive maximum value. Market Regulator (SEBI) has prescribed 6 scales of risk for ease of investor understanding of every mutual fund product, these are Low, Low to Moderate, Moderate, Moderately High, High, Very High. The depiction of risk shall be through pictorial meter named "Risk-o-meter" and this meter would appropriately depict the level of risk in any specific scheme This risk-o-meter enables the investor to understand the risk level of the scheme and make investment basis their risk appetite.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.