All financial products carry risks, judicious selection and smart planning can lower those substantially

 

There is a perception among a large number of savers and some investors that mutual funds are more risky financial instruments compared to traditional ones like bank fixed deposits, gold, real estate etc.There is an historical basis to that, but the ground realities are very different: Mutual fu nds as financial products can help mitigate risks asso ciated with financial instruments.

The perception of higher risks for mutual funds mainly emanates from the fact that earlier when fund houses charged entry loads, that is investors paid to invest in schemes, the fund houses passed on those charges to distributors as commissions who got the investors. And a large number of distributors sold those products which paid higher commissions, even if the funds didn't perform well. Also some distributors got first time investors into equity funds when markets were at a high and there was huge euphoria all around. Most investors who came at markets' highs, usually didn't see much gain, or even incurred losses for the next few years, which turned them away from mutual funds, terming them as risky assets.

Things have changed completely now after Sebi abolished entry loads in August 2009, combined with the proactive steps taken by Sebi and the growing influence of financial planners and advisors who put inter ests of in vestors ahead of other things.

To mitigate risks to investing, people should focus on two main factors:

The risks to capital and risk of inflation.

 

One can address the risks to capital by investing in equities through mutual funds for the long term. Equities are risky in the short to medium term. But if you invest in equities through mutual funds, that too through the systematic investment plan (SIP) route that gives you the advantage of averaging, you can turn the disadvantage (the risks associated with stocks) to your advantage.

The next is beating the inflation. According to financial planners and advisors, FDs can give you safety but they give returns tied to the rate of inflation. On top of that returns are also taxable. So the real return after taxation is lower than inflation. "One needs to invest in a manner than beats inflation. According to him, equity investment in the long run is tax free and also most of the times they give returns which can beat inflation by a good margin.

Investors also have the perception that mutual fund means equities which are risky while the fact is 70% of the industry's money is in debt funds which are relatively less risky. However, most first time investors invest in equities because they are easier to understand than debt. But in the short to medium term equities are more risky that debt. If we consider the sensex as a benchmark for equity investing, if you remain invested in equities for more than 12 years or more, your probability to gain from your equity investments is 100% (see chart below

To mitigate risks of investing further, investors should resort to two more things: They should do a proper risk profiling while starting to invest, and they should also do a regular review of their investments. A proper review and rebalancing always helps one remain on track while investing