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3 Ways to Reduce Mutual Fund Investment Risks

Mutual funds are exposed to market risks; therefore, you should assess your risk tolerance before investing in them. Risk tolerance is the extent of risk you want to take with your investments. Taking a higher risk can increase the chances of getting higher returns, especially over the long term. Although there's no guarantee, choose the kind of fund that suits your risk appetite. This is the first step towards reducing investment risks. Wish to know about some other ways too? Here are 3 additional tips to reduce the risk associated with your mutual fund investments.

Diversify Your Portfolio

Diversification is crucial for investments. To diversify your portfolio, you can invest in a mix of assets so that profits from one investment can offset losses from another. You can diversify your investments in these ways:

Invest in weakly correlated asset classes: Invest in a combination of equities and debt funds. Debt funds are suitable for steady and fixed income at lower risk over a short period. Equities come with a higher risk but have the potential to yield higher returns over a long investment horizon. Consider investing in Equity-Linked Savings Scheme (ELSS) mutual funds to enjoy tax benefits.

Diversify across sectors: Consider investing in a mix of focused, contra, and sectoral equity funds since they invest in different sectors.

Diversify across market capitalisation segments: Consider including small-cap, mid-cap, and large-cap funds in your portfolio to have the best of all the types of market cap segments.

Invest Via SIP

A systematic investment plan (SIP) allows you to invest a small fixed amount of money in a mutual fund at a specific regular interval. The best SIP helps reduce your overall risk of investment through rupee cost averaging. It refers to buying more units when the market prices are low and fewer units when the prices rise at the same cost. This way, you can average the investment cost and lower your overall risk. Besides, since you can invest a small amount periodically, it doesn't burn a hole in your pocket. You can't get these benefits with a lumpsum investment.

Invest for the Long Term

Another way to reduce your risk of investments in mutual funds is to invest for the long term. This is especially true for high-risk options like equity funds such as ELSS mutual funds. Long-term investments can help survive short-term market volatility. You can also gain more with the power of compounding as your profits would be invested again in the market to generate higher returns. Therefore, it's best to avoid sudden exits stemming from panic when you see short-term market fluctuations. Instead, try to remain invested over the long term with patience and persistence.

Whenever you wish to increase your investment amount to achieve your goal despite rising inflation, consider stepping up the best SIP plan. That way, you can reduce the risk of the erosion of your purchasing power.
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