Risk is the most misinterpreted term in the world of investments and is often related to phrases like, “the higher the risk, the higher are the returns”. But its opposite can also be true, which is lower or negative returns. Most investment advisors feel that investors never connect risk to losing capital and it is important for investors to understand every aspect of risk associated with investments.
The evolution of the mutual fund industry in India and the introduction of Direct Plan Mutual Funds has drastically changed the dynamics of mutual fund investments. Now, more and more investors are turning towards investing in direct mutual funds offered by OroWealth compared to the regular funds because of the benefits involved in terms of higher returns and freedom in selecting funds according to the investment objective.
But, for a new investor, investing in direct plan mutual funds always carry a risk. From risk of selecting a wrong mutual fund to failing to review the investment portfolio. In this article, we will discuss about different risks faced by a new investor while investing in direct plan mutual funds.
Framing Investment Objective
The framing up of an investment objective or goal is the most important aspect of any starting an investment. It is just information which details your long term financial goals, risk appetite, the period of investment, etc. through which optimal portfolio mix is determined. It is prepared by your registered investment advisors, robo-advisors, or can be self-made if you are managing your funds.
Having a defined investment objective is not necessary, but without a plan, chances of failing to reach the optimal return levels are very high. And, for a new investor, investing without proper investment goals on their own is very risky.
Failing to Measure the Right Risk Tolerance Level
Every individual has a certain degree of risk appetite, which means how much a person can absorb losses in case of non-performance of the market. Risk appetite is determined by the investor’s age, income & expense level, short term financial goals, and insurance cover (both life and health) of the investor.
Also, the investment time frame is a crucial factor in determining risk tolerance in the investment. Lesser the investment time frame lower should be the risk tolerance level whereas higher the investment time horizon, higher should be the risk appetite.
Failure to measure the right level of risk appetite could lead to havoc on your investment goals and also lead to loss of capital.
Risk of Selecting the Wrong Mutual Fund
There are seven different types of mutual funds ranging from equity and debt to hybrid funds available in the market which are selected according to the investment objective. Beginners in the world of investment are at a greater risk of selecting the wrong mutual fund scheme which is not according to the risk appetite and also investment objective.
For example: Pure equity funds are known for their higher level of risk compared to hybrid funds which have both, equity and debt securities in its portfolio. But, in equity funds, returns percentage is higher over a long period of time compared to hybrid funds.
Risk of Failing to Understand Different Investment Risk
The return on investment is affected by a multitude of factors like country risk, credit risk, currency risk, interest rate risk, liquidity risk and market risk. Failing to understand which risk factor affects the investment most and effectively managing it protect the returns can lead to loss of capital and achieving the investment objective.
For example: Equity mutual funds are most affected by country risk, market risk and liquidity risk whereas, debt mutual funds are most affected by credit risk, interest rate risk and liquidity risk. An investor needs to factor in all the risk scenarios before investing in a fund.
Risk of Failing to Review Mutual Fund Portfolio
A mutual fund portfolio should be reviewed periodically in order to analyse whether the returns and performance of the funds are according to the investment objective. If there are any major deviations in the returns of the fund, then the investor needs to take corrective measures to achieve the investment objective smoothly.
Failing to review investment portfolio means increased risk of holding onto investments that are not performing and no longer suit your portfolio.
Lack of Knowledge
There are several mutual fund types available in the market which suits the needs of varied investment objective and each mutual fund type has a very different structure and style of working. There are several key factors associated with the funds that an investor should know while selecting direct plan mutual funds.
For instance, the performance of an equity fund is measured through its past performance and checking vital stats like Alpha, Sharpe Ratio, beta, and Standard Deviation which measures the performance on different risk-adjusted parameters.
However, in a debt mutual fund or fixed income space, the past performance of the fund is not looked after, but stats like Modified Duration, Average Duration play a major role in deciding the returns of the fund.
Investing in Direct Plan Mutual Funds surely comes with benefits like higher returns and freedom in selecting a mutual fund but it is accompanied with added responsibilities. Research funds independently, select the right fund, and then go through the investing process without the help of an intermediary. After you have gone through these steps, periodically review the investment portfolio and make changes accordingly.
However, for a new and inexperienced investor, it’s a huge task to invest in a direct plan mutual fund and it is also not feasible because of higher risk ratios.