If you are an investor in financial markets, you might be exposed to risks which are unforeseeable. However, being aware of these associated risks and knowing how to steer your portfolio through these risks by investing in mutual funds is extremely important.

Investment risks can broadly be categorized into six types as under:

1. Market Risk: Market risk means the risk of investments declining in value because of economic developments or other events that affect the entire market. These may be further subcategorized into three types’ viz. equity risk, interest rate risk and currency risk.

   • Equity risk: It means the risk involved while investing in equity shares. The market price of shares varies all the time depending on demand and supply. Equity risk is the risk of loss because of a drop in the market price of shares. You cannot avoid this risk but can manage this risk by investing in equity mutual funds since these are managed by professional fund managers who are expert in their field. They select and invest in shares after thorough research and in turn aim to minimize the risks involved in equity investing.

   • Interest rate risk: It applies to debt investments such as fixed income instruments. It is the risk of losing money because of a change in the interest rate. For example, if the interest rate rises, the market value of fixed income instruments will drop. You can avoid such risk by investing in mutual funds like dynamic bond fund or short duration debt funds.

   • Currency risk: It applies when you put money in foreign investments. It is the risk of losing money because of a movement in the exchange rate. By investing in a mutual fund, you can count on the professional mutual fund managers to appropriately manage your foreign investments and aim to protect yourself from any loss due to foreign currency fluctuation.

2. Liquidity risk: Liquidity risk refers to the possibility that you may not be able to sell your investments and raise money from it when needed. For example, real estate is not very liquid. The risk with such assets is that they are not very easy to sell due to lack of opportunities. Therefore, investing in a mutual fund that provides an investment opportunity in such asset classes could be a good option for you. It can help you take advantage and gain exposure to the illiquid market.
   
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3. Concentration risk: It refers to the risk of loss because your money is concentrated into one type of investment. When you diversify your investments, the risk is spread over different types of investments, industries, and geographic locations. Diversification helps considerably reduce the unsystematic risk of the portfolio. The mutual funds offer reasonable diversification enabling you to mitigate such risks.

4. Credit risk: Credit risk means that the entity or company that issued the fixed income instruments may run into financial difficulties, and it won’t be able to pay back the principal or interest on maturity. Credit risk applies to debt investments such as fixed income instruments. However, mutual funds evaluate credit risk by looking at the credit rating of these instruments. A large part of their portfolio generally consists of AAA rated securities that are thoroughly researched and backed by appropriate collateral.

5. Reinvestment risk: This is the risk of loss from reinvesting the principal or income at a lower interest rate. If you are earning a certain rate of interest on your traditional saving instruments or fixed income instruments say 6% and if the interest rates drop to say 4%, then your capital will henceforth be reinvested at this lower rate. It is a risk in a decreasing interest rate environment. Investing in actively managed debt mutual funds provides a safety net to your investments from this risk.

6. Inflation risk: Inflation risk is the risk of a loss in purchasing power because the value of investments does not keep up with inflation. Inflation erodes the purchasing power of money over time. This means that the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant if you own cash or debt investments like fixed income instruments. There are various asset classes that are known to beat inflation. Investing in stocks can offer you some protection against inflation because most companies can pass on the higher input costs to their customers. Share prices should therefore rise in line with inflation. An investment in immovable property may also offer you some protection because the landlords can increase rents over time. Currency depreciation and precious metals treated as a haven in distressing times may prove to be effective against inflation at certain times. There are various mutual fund schemes that provide an exposure to all the above asset classes.

To summarize, the framework to mitigate risks associated by investing into the capital markets and other asset classes with it has been drafted carefully by professional fund managers whose experience runs into many decades. Don’t let the risks mentioned above deter you. With right Mutual Fund schemes, you can understand your risks and count on experts for a comprehensive risk management strategy towards wealth creation.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.