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The modern way of investing in mutual funds took shape in Boston in 1924 when Massachusetts Investors’ Trust came up with its first mutual funds that allowed open and continuous share issue and redemption. Since then, various types of mutual funds have come into the market.
Now, the most crucial thing to note is that not all funds offer the same benefits. Thus, it becomes important for you to know how to differentiate between high risk vs low risk mutual funds.
Depending upon their risk and reward levels, mutual funds can help you build wealth. Check out this blog for more insights on these mutual funds. Here’s a quick look into what sets them apart.
What are high risk high return mutual funds?
These funds invest in assets that can offer potentially high returns. However, they also come with a higher level of risk. These high-risk funds are also known as growth or equity funds and are highly prone to market volatility.
For example, the Aditya Birla Sun Life PSU Equity Fund Direct-Growth, which is managed by Aditya Birla Sun Life AMC Limited, has an AUM of Rs. 3,329.97 crores and has a very high risk associated with it. However, it has offered 103.22% returns in the past year and 212.43% absolute returns over the past three years!
Target investors
These investments are suitable for you if you have a high-risk tolerance and a longer investment horizon. Additionally, if you’re someone who can handle short-term fluctuations for substantial long-term gains, these financial products are made for you.
Return potential
High-risk mutual funds can offer remarkably high returns because they typically invest in emerging markets. For instance, high-growth sectors like technology have seen funds deliver annualised returns upwards of 15-20% in bullish market conditions.
What are low risk mutual funds?
Low-risk mutual funds focus on giving stable returns with lower volatility and are mostly used for capital preservation. These funds are majorly composed of debt instruments such as government securities, high-grade corporate bonds, and other fixed-income instruments.
The HDFC Liquid Fund Direct-Growth, managed by HDFC Asset Management Company Limited, falls under the low risk mutual funds category. It has an AUM of Rs. 47,222.3 crores and offered a 7.3% return in the past year and a 17.48% return in the past three years. The return might seem lower than any high-risk mutual fund since it is a low-risk investment option.
Target investors
This type of investment is suitable for you if your main objective is to preserve your capital while earning returns slightly above those of traditional saving instruments. This type of mutual fund is perfect if you have a low-risk appetite and are satisfied with low but steady returns!
Return potential
While the returns are generally lower than high-risk funds, they are more predictable. Annualised returns of 6-8% are standard, depending on the interest rate environment and the fund’s portfolio composition.
Types of risk in mutual funds
There are many types of risks involved when dealing with mutual funds. So, understanding these risks is important for investors trying to gain a better understanding of high vs low risk mutual funds. These risks directly impact investment strategy and the potential for returns vs. losses in varying market conditions.
- Market risk
It reflects the vulnerability of your mutual fund’s value to the movements in the financial markets. It’s a reminder that when the market is bearish or bullish, your investment will likely follow suit.
- Credit risk
It involves the possibility that the issuers of the debt securities in your mutual fund might fail to meet their obligations, such as paying back principal or interest on time.
This risk is usually associated with low risk mutual funds that invest in corporate bonds or debentures, where a default could impact returns. These funds usually try to minimise exposure to this risk by investing in higher-quality, lower-yield securities.
- Interest rate risk
There is a risk that changes in interest rates will affect the value of the securities in a mutual fund. When interest rates experience a rise and as a consequence, bond prices fall, and vice versa. This type of risk concerns funds that deal with fixed-income securities such as the low risk mutual funds. It can influence the strategic risk in mutual fund investments.
- Liquidity risk
Liquidity risk arises when it becomes difficult to liquidate your investments and exchange them for cash. When a mutual fund holds securities that are difficult to sell quickly, holders may have to sell at a lower price, affecting fund performance. Risks of this type are high in funds that hold investments in emerging markets with low trading volumes.
Conclusion
Different mutual funds offer different returns based on the level of risk you are willing to take. For instance, in 2008, the market fell, and high-risk players felt the heat. Those in lower-risk funds slept a bit better, knowing their investments were more cushioned against the crash. Fast forward to 2020, and there was a market boom with COVID-19.
All you have to do is to ensure that you have a deep understanding of the risks involved and diversify your portfolio to ensure that these risks can be mitigated. For more info on mutual funds and other financial titbits, visit StockGro today!
FAQs
Mutual funds are considered high risk based on their investment in assets with higher volatility and returns. High-risk funds seek higher growth but are more likely to fluctuate in value.
Low-risk mutual funds focus on capital preservation and stability, while high-risk mutual funds focus on wealth creation. Low-risk funds are mainly invested in debt instruments like government securities and high-grade corporate bonds. They are predictable, give lower returns, and are less affected by market volatility.
When assessing risk tolerance, you should consider your financial goals, investment horizon, and risk appetite. High-risk mutual funds might be suitable if you aim for long-term growth and are willing to endure short-term market fluctuations. Likewise, low-risk mutual funds could be a better fit if your primary goal is capital preservation and if you are fine with steady returns.
High-risk mutual funds usually are not suggested for short-term investments due to their volatility. They are better suited for the long term as you can ride out market fluctuations for higher returns.
While low-risk mutual funds aim to lower volatility and preserve capital, they are not entirely risk-free. Economic factors and interest rate changes can still lead to losses, generally lower than those associated with high-risk funds.
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