How to manage risk in mutual funds

Suppose you're trying to get into shape. You create a routine and make small changes to your lifestyle. One of these key changes is improving your diet. You could try a crash diet to shed pounds quickly, but soon, you will fall off the wagon. Instead, it's better to focus on a sustainable, rewarding diet. The goal is to feel good about your progress, not dread every meal of boiled chicken and rice. Similarly, when it comes to investing, there's a unique risk-return level that each investor is comfortable with. If you chase quick returns, it will often be at the expense of peaceful sleep. However, if you take minimal risk, chances are your wealth will grow at a snail's pace. Therefore, you need to have a balanced approach. In this article, you will learn how to manage risk without compromising on returns. Also, we'll walk you through how risk varies across different mutual funds. What is risk in mutual funds? It refers to the possibility that an investor may lose money or earn returns that are lower than expected. Every investment carries some level of risk, and mutual funds are no exception. These risks can be associated with various factors like market fluctuations, interest rate changes, or the performance of the underlying assets in the fund's portfolio. Types of risk in mutual funds Market risk: This refers to the fluctuations in the market, driven by changes in stock and bond prices. Market risk can impact all types of mutual funds, but equity funds are particularly susceptible due to their exposure to stock market movements. Interest rate risk: This type of risk primarily affects debt mutual funds. When interest rates rise, bond prices tend to fall, and this can impact the value of the bonds held in a mutual fund's portfolio. Credit risk: This involves the risk of bond issuers defaulting on their payments. Funds that invest in lower-rated bonds face higher credit risk compared to those investing in, say, government bonds. Inflation risk: Inflation erodes the purchasing power of your returns over time. If a mutual fund's returns do not outpace inflation, your investment could lose substantial value over many years. Liquidity risk: This risk arises when investors face difficulty selling their mutual fund units quickly without affecting the price. Liquidity risk is more relevant to less-traded funds or those investing in illiquid assets. Suggested read: Understanding risk in mutual funds How can you categorise mutual funds by risk level? Different mutual funds carry varying levels of risk depending on their investment strategy and the type of assets they invest in. Here's how you can categorise them: Low-risk mutual funds (Best for conservative investors) Low-risk mutual funds are typically ideal for conservative investors who seek stability and safety in their investments. Liquid funds & Overnight funds: These funds invest in s

This article was originally published on May 13, 2025.