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How safe are your mutual fund investments

How safe are your mutual fund investments?

Fund : An amount of money saved or collected for a particular purpose

Return : Profit or loss derived from an investment

Investor : An investor is any party that makes an investment.

As an investor, we invest money with the primary objective of making positive returns through them. Mutual funds are one of the most popular investment vehicles across the globe. It is very lucrative, and it has the magnetic effect of luring more and more investors. Though the mutual fund considers as a safe way of investing for return, the underlying fact is that none of the mutual funds are safe.

Wondering what this really means?

Well, how safe or unsafe your mutual fund depends on how you invest in them. Read on.

Are mutual funds safe investments?

When it comes to investments, there are two types of safety in general.

1.Safety with reference to mutual fund company absconding with your invested money.

2.Safety of principal and assured returns.

To understand how mutual funds are safe, let us discuss this in detail under 10 different points. 

1. Absconding with your invested money!

Please be 100% assured that a mutual fund company will not run away with your money.

All mutual fund companies are regulated and monitored by SEBI and AMFI. The priority for SEBI is to protect the investor’s interest. Undeniably, India has the strict rules and stringent norms for setting up of Asset Management companies.

There are rigorous prerequisites like experience in the financial market, capital requirements, and past record, to set up a mutual fund company.

If a company applies for a license to run a mutual fund company, it has to go through a detailed due diligence process like licensing process to start a bank.

That means the mutual fund company enjoys the similar amount of safety like banks with regards to the flight risk.

2. Exposed to Scams!

SEBI has set up and implemented clear guiding instructions to all the mutual fund participants – sponsors, trust, AMC, custodians, and distributors. It makes mutual funds a trustable investment option.

The main goal of the board of trustees is to safeguard and secure the investor interest. Minimum two-thirds of the directors need to be independent. Trustees supervise the fund house complying with SEBI guidelines.

It reduces the possibility of minor or major scams in mutual funds.

3. Is my money safe even if the mutual fund is bought by another?

Absolutely, Yes. When a mutual fund company acquires another mutual fund company, it takes over all the schemes. If they would like to shut down any of the acquired schemes, they will return the money to the investors at the prevailing NAV.

4. Is it absolutely safe to invest in Mutual Funds?

As discussed earlier, a mutual fund investor will not lose the invested money by any scams or a mutual fund company flying away with the money or merging with other mutual fund company.

However, the mutual funds don’t guarantee the capital protection and don’t assure the returns. There is a possibility that the mutual funds may generate poor returns or negative returns because of poor performance.
 

Different Types of Risks associated with Mutual Funds

 a) Market Risk:

This risk is applicable to both equity funds and debt funds. If the stock market or debt market is not doing well, it will affect the performance of equity funds and debt funds.

An investor can secure himself to some extent from market risk by diversifying your investments in different markets and also choosing to stay in the market for the long term.

b) Liquidity Risk:

Even this is applicable to equity funds and debt funds. If the stock or debt market instrument in which the mutual fund has invested is not getting traded in the market, then it will be difficult for the mutual fund to liquidate that security.

You can safeguard yourself from the liquidity risk by diligently selecting the mutual funds to invest.

c) Credit Risk:

This risk is applicable to debt funds. If the underlying security issue is not able to repay, it is known as credit risk or default risk.

As a safety measure, you can analyse the credit ratings of the underlying securities and reduce the credit risk.

d) Interest Rate Risk:

This risk is also applicable to debt funds. When the interest rate goes up, the value of fixed income instruments will fall down. You can safely control the interest rate risk by choosing the accrual-based debt funds and avoiding duration based funds.

5. Can I lose all my money in mutual funds?

We have different types of risks associated with mutual funds; you may ask “Can I lose all my invested money in a mutual fund?”

The mutual funds invest in different stocks and debt instruments of different companies, the possibility of all the companies will fail is extremely less. So, the possibility of you losing all your invested money in the mutual fund is really remote.

However, if the entire economy fails, then all the companies in the economy will also fail.

6. Is Mutual Fund SIP Safe?

SIP will reduce the risk by investing in the market in a staggered way. It restricts you from entering at the very peak of the market. As you invest monthly or some periodically your investment cost will be averaged out.

However, it doesn’t mean that your Mutual Fund SIP is 100% safe. It also carries all the 4 risks which we have discussed earlier.

7. How safe are debt funds?

Debt funds are comparatively safer to equity funds. Debt funds invest their money in the fixed income yielding instruments. As discussed earlier, debt funds have credit risk and interest rate risk.

  • Check the portfolio and analyse the credit ratings of the securities.
  •  Choose accrual based debt funds and avoid duration based debt funds.
  •  Choose the debt funds whose Average maturity is closer to your investment time horizon.

If you follow the above safety measures, then your debt funds will be a better alternative to fixed deposits.

8. Additional Safety quotient:

There are few other features of mutual funds that increase the safety quotient of mutual fund investments.

a. Diversification:

The fund houses are investing your money in multiple securities. Even if one security incurs a loss, that can compensate for other performing securities.

b.  Professionally managed:

The mutual funds managed by professional fund managers; they will work towards reducing the market risk, credit risk, liquidity risk and interest rate risk.

c.  Transparency:

The Mutual funds need to be transparent in disclosing their portfolio periodically by the regulations. This transparent fund management system and daily NAV disclosure add more safety to mutual fund investments.

d. Liquidity:

Mutual fund investments are highly liquid. All open-ended mutual fund units can be sold back to the mutual fund itself. You can convert your mutual fund investments into cash at anytime. It is a unique feature of a mutual fund. Other investments like real estate are highly illiquid.

9.  Is it safe to invest in mutual funds online?

You will be sharing the personal and financial information when you are investing in online. How are this information kept confidentially? Is there a possibility that someone can take advantage of and exploit the data?

The answer is NO because all online platforms follow the required encryption protocols to secure your data.

Online platforms are as safe as offline investments. It provides more convenience for an investor.

10.  How to be safe with Mutual Funds?

Consider electrical equipment like an iron box. If you handle it carefully, adjusting the temperatures based on the fabric, it can yield wonderful results, but when you fail to abide by its usage instructions the results can be disastrous. You not only risk your clothes being ruined but can also harm yourself. So, is using an iron box safe or unsafe? The answer is both!

‘Safe’ is a relative word and has different connotations for different investors.

When you correlate the above example with mutual funds, it reiterates the understanding that all mutual funds are safe, if you know what, where and why you are investing in them. Just like adjusting the temperature according to the fabric, you need to realign the asset allocations based on the timeframe of the investment and your growth, return requirement.

If you are new in the mutual fund investing, understand and educate yourself about the different mutual fund schemes suitable for different timeframes. The rationale behind every investment needs to be prudently planned.

Safety and SEBI colour-code Guidelines on mutual funds

In an effort to demystify mutual fund investing, and to make the exercise colourful and to worthwhile, the SEBI has drafted guidelines on mutual fund product labelling. All mutual fund schemes will have a colour coding – Blue, yellow, and brown.

As a practice, mutual fund schemes carry labels which disclose information about the investment objectives, the category of the investment and likewise. With the introduction of colour codes, the risk level in the said mutual fund scheme is also transparent to the investor.

Apart from the colour codes, these labels will also indicate whether:

  1. It is a scheme for wealth creation  or regular income; short-term or long-term
  2. It invests in equity-based funds, debt fundsgold or a mix of them.

What do these mutual fund colour codes mean?

 
The SEBI has played ‘holi’ with mutual funds investing, making the labels colourful and meaningful!

Below are the details:

Blue: Low risk

Debt schemes such as debt mutual funds, fixed maturity plan, liquid funds and gilt funds etc. which carry low risk would indicate blue on the label. It is primarily for risk-averse investors.

 Yellow: Medium risk

Hybrid mutual fund products such as monthly income plans, balanced mutual funds etc., which carry moderate risk, fall under this category.

Brown: High risk

All equity investment schemes such as the diversified equity funds, mid-cap and small-cap funds, and index funds etc. which associate themselves with high-risk fall in this colour code. It suits to the investors who are highly tolerant of risk and have the long-term time frame for their investments.

How does product labelling benefit mutual fund investors?

A traffic signal on the road helps the pedestrian know when he can cross safely, and also avoid accidents, similar are the labels designed by SEBI. It helps investors understand how safe or risk-prone his investment would be.

One of the main requisites of investors would be to ensure that his capital does not erode, and the principal amount invested remains safe. Choosing the funds based on the label colour indicates the risk associated with the schemes, thereby educating the investors.

  • With product labelling, the incidence of investors falling prey to brokers and agents are
  • All the data about the associated risk is available to the investors and they cannot be misguided by the agents.
  • The stakeholder can select his scheme as per his investment time horizon and trade wisely by comprehending the nuances of the pooled funds.

Smoother Investment Journey

Investing is both a science and art. It’s the art of using creativity and judgment to plan financial goals and maximizing returns. The investment journey is a bumpy ride, and the science of collecting and analysing investment data ensures that you don’t lose directions on the way to your destination.

Education, awareness, and prudence while investing can ensure that your investment journey with mutual funds can be fruitful and productive.

Hope the above points could have given you a right perspective about mutual funds.

To get the right perspective about your complete personal finance, you need to have a healthy financial plan. If you want to understand our 360-degree financial planning process, we offer
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7 thoughts on “How safe are your mutual fund investments?”

    1. Dear Pinal Kumar,

      Balanced Funds can deliver around 10% year on year on an average. Depends on the market returns in one particular year the returns may be more or less. But in the long run, we can expect around 10% from balanced funds.

      Ramalingam

    1. Dear RC Goyal,

      There is nor Risk Free + Tax Free investment except PPF.

      Other investments come with some amount of risk.

      There is a lesser risk + lesser tax liability investment which is debt fund. Depnding on your time frame of investment, you can choose an accrual based fund with the right average maturity.

      Regards
      Ramalingam

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