5 Ways to Reduce Risk in Your Mutual Fund Portfolio
Mutual funds can be a great way to earn capital appreciation over the long term. These are a pool of professionally managed funds that invest in a diversified portfolio of securities to help the scheme and its investors achieve a common investment objective. Although mutual fund schemes are known to offer decent risk adjusted returns, investors are expected to determine their appetite for risk before making an investment decision.
Although we aspire to improve our existing financial condition, our annual income may not always be able to suffice that need. This is why most individuals turn to investment options like mutual funds as they hold the potential to offer returns better than any other investment avenue. A well-diversified mutual fund portfolio can be successful in long term wealth creation. But investors must learn to keep their portfolio well diversified.
To key to wealth creation is to have a mutual fund portfolio that will offer best risk adjusted returns. And to ensure that you are on the right path, here are 5 ways to reduce risk of your mutual fund portfolio –
Understand your appetite for risk – An individual’s risk appetite is determined by understanding their risk tolerance. One should only invest how much they can afford to lose. Remember to not invest your entire life savings in mutual funds. Mutual funds are highly volatile in nature. Although they hold the potential to generate higher returns, they can also make your portfolio suffer over the short term. An investor’s age can play a huge role in determining their risk appetite. For example, someone in the early 20s who have recently kicked off their professional journey can take higher risks. Such individuals do not have any other responsibilities and hence can take maximum risk to maximize profits. However, investors in their mid 40s may have existing liabilities and might not be able to take greater risks.
Apply asset allocation strategy – Asset allocation is the art of investing certain portions of your money in various asset classes so that your mutual fund portfolio is able to churn higher returns while minimizing overall investment risk. Depending your appetite for risk, investors can invest in assets like equity, debt, gold, real estate, etc. to create a proper mix. This is to ensure that if one asset class underperforms, investments in another asset class is able to provide the necessary cushion.
Diversify your mutual fund portfolio – An investor must diversify his / her portfolio based on their risk appetite.Investors are usually left confused with asset allocation and portfolio diversification. Before diversifying your mutual fund portfolio, investors should first determine which asset classes they must invest in. To further support their decision, investors should accordingly diversify their mutual fund portfolio.
Sufficient liquidity must be ensured – Some mutual fund schemes like ELSS come with a predetermined lock in period of three years. During this time in case an investor faces an exigency he / she must be able to liquidate their assets immediately to tend to the scenario. This is why investors should always ensure that their mutual fund portfolio has enough liquidity. For this, they can consider adding debt funds like liquid funds or overnight funds that offer instant unit redemption facility.
Start a monthly SIP – The best way to ensure that you reduce investment risk and maximize profits is to start a monthly SIP in a mutual fund scheme of your choice. SIPs take advantage of the fluctuating markets and allot more units to investors when the markets are low. This is known as rupee cost averaging. SIPs over the long term can also allow investors to benefit from power of compounding.
These are a few ways to reduce your mutual fund portfolio’s overall risk. To seek deeper understanding about the same, please seeking professional consultation.