While investing, it is easy to fall for the desire of fetching as much return one can possibly get. And with the rapid increase in mutual fund schemes and their attractive returns, it is rational to wonder if they are safe to invest in at the first place. The significance of safety depends on person-to-person, but these are the most common factors that constitute the risk profile of an investment :

1. Loss of principal (loss of invested money).
2. Poor returns (loss of opportunity cost).
3. Absence of liquidity (illiquid and lock-in schemes).

Here is how mutual funds perform at each of these factors in different ways :

• Investing heavily into the index: Many mutual fund schemes hold a significant portion of their portfolio into various kinds of indexes. The reason behind shadowing the index is that the index is already highly diversified, is less risky than individual stocks, and it mimics the direction of the market in general rather than facing heavy fluctuations on a daily basis. This lowers down the risk of loss of original money, as it is highly improbable that all industries and indexes go down together. Many mutual funds like to invest a significant portion of the money into an index such as Nifty Bank, Nifty IT, Nifty FMCG, and some mutual fund apps allow you to customize your portion into the index of your choice

• Diversification: To reduce the chances of loss of funds while providing enough room to enjoy significant returns, all mutual fund managers include a variety of assets and indexes, such as equity and debt, hybrid funds, contra equity, growth equity, large-cap, mid-cap, small-cap, international stocks, metals, etc. This wide range of assets helps them keep the pool of investment highly diversified so that a handful of events cannot wipe out the funds of investors. And as some investments perform far better than others, this strategy does not need managers to pick out the big hitters individually, as they all become a part of the pool.

• Low entry price: One of the most common functions of mutual funds is SIPs (Systematic Investment Plans). This feature of investment enables people to buy assets every month, which helps them buy assets also when they are trading below their true (or intrinsic) value. Low entry also means that investors have less money at stake in individual assets, which lowers the risk of losses further. Many mutual fund apps enable investors to add more money than their SIPs, which is especially useful in market corrections.

• Government regulations: Because mutual fund managers control the money of millions of people, the government shall ensure that the wrong decisions of these managers does not risk the hard-earned money of investors. SEBI (Securities and Exchange Board of India), on behalf of the government, takes care of this by providing instructions to these managers and monitoring the pool of funds to ensure that money is held responsibly. Also, all managers need to follow the minimum standards of asset allocation and diversification. Some mutual fund apps even provide updates on changes in related government policies.

• Controlled exposure: Because the mutual fund portfolio consists of the funds of the public, a huge part of which is a layman’s money, SEBI restricts mutual fund managers from investing more than a reasonable amount of the money in one asset. Such restrictions range from owning a particular asset to owning a whole asset class. For example, any particular portfolio cannot own more than 10% of one listed share and 5% of one unlisted share, 10% bonds of a particular issuer of debt, and 25% bonds of a particular sector.

• Investments as per risk tolerance: Different investors have different investment needs, such as more returns, short lock-in periods and liquidity, less risk tolerance, etc. Mutual fund managers invest in a variety of securities in order to match the investment objectives of investors so that their money is safe as per their terms and they can sleep peacefully at night. For example, mutual fund managers will probably put 80% of a young investor’s money in equity-based funds, whereas only 30% of the money in equity-based funds of an investor in his 50s. There are open-ended schemes where investors do not need to lock their money for a minimum duration.

Conclusion

Mutual funds manage to attract billions of rupees every year because they are a safe investment from the risk point of view, as they diversify strategically, invest as per the requirements of investors, and are strictly regulated by SEBI. In closure, we can say that mutual funds not only provide handsome returns, but are also safe from major risks. These days, money in mutual funds can also be invested via a mutual fund app, which are simple, safe, and user-friendly.