How to Avoid Risks in SIP Investments

Believe it or not but every investment there is some kind of risk associated. It all depends on the individual as to how much risk he or she should take while making an investment. A lot of people feel that high risk investments fetch higher rewards but this may or may not be true in every scenario. When you invest in mutual funds, be it equity, debt, hybrid, ETF or any other scheme, there is always some risk involved.

If you invest in mutual funds regularly you will be aware of the statutory mutual fund warning that goes by - Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. But most of the time, investors tend to not take this seriously and ignore the caution. However, if you are someone who predominantly invests in mutual funds, you need to understand the risks that are involved with these investments.

Usually there are two types of market risks involved when you invest in mutual funds -

Systematic Risk

These are risks which cannot be predicted beforehand but to some level, you might be able to avoid them. This type of risk includes political tension, fluctuations in exchange rates, natural calamities or pandemics, etc.

Unsystematic Risk

Generally, it is the duty of the fund manager to take care of these risks. But as a mutual fund investor you too should be aware of them. Three major categories of unsystematic risk include concentration risk, liquidity risk and business risk. Let us understand how these three risks might impact your mutual funds.

• Business risk: A business risk is nothing but the fear of a particular sector or company underperforming or generating lower profits than what is expected from them. There are numerous factors that may drive a business towards loss. These include intense competition from rivals, government regulations, economic conditions, etc.

• Concentration risk: Concentration risk when you turn a blind eye on opportunities that offer diversification and solely remain invested in a particular scheme or a particular sector for a longer time period.

• Liquidity risk: Liquid risk is a fund’s inability to liquidate easily. When you issue redemption of your mutual fund units but if it doesn’t happen as quickly as anticipated, liquidity risk is involved.

Risks in mutual funds solely depend on the sectors they invest in. For example, equity funds invest predominantly in equity and equity related instruments, thus exposing a greater chunk of an individual’s investment to the volatile market condition. A mutual fund like a hybrid fund aims at balancing risk by investing in both equity and debt instruments. Also, the way you choose to invest in mutual funds may also impact the risk.

You must be aware that usually there are two ways you can invest in mutual funds - either through lumpsum investment or via SIP.

When you pay in lumpsum, you pay the entire mutual fund investment amount at the beginning of the investment cycle. This type of investment is generally preferred by those investors who have surplus cash parked which they feel may be put to better use. A positive side to lumpsum investment is that investors are allotted more number of units in proportion to the money they invested and depending on the fund’s existing net asset value of NAV. But remember that your entire investment amount is exposed to volatile market conditions in lumpsum mutual fund investments and this can be avoid if you start an SIP instead.

Systematic Investment Plan or SIP is designed to give mutual fund investments a systematic approach. If you want to start a mutual fund SIP, all you need to do is instruct your bank and every month on a predetermined date, a fixed amount is debited from your savings account and transferred to the mutual fund app. This way, you can start investing in mutual funds with an amount you are comfortable investing at regular intervals. Also, SIP may even help an investor in inculcating the discipline of regular investing. SIP investors also tend to benefit from compounding if one remains invested for the long run.

How to avoid risk in SIP investments?

If you are starting a mutual fund SIP, remember to keep a long term investment horizon if you want to avoid risk. That’s because unless you continue investing for at least seven to ten years, SIP investments might not be able to offer you decent capital gains. Also, only when you remain invested for a longer period of time, you may benefit from compounding. Also, as the famous saying goes ‘do not keep all your eggs in one basket’, diversification is the key to minimize market risk when investing in mutual funds via SIP. Diversification allows you to balance your mutual fund portfolio. It is always advisable to have a mix of equity, debt and ETF funds in your folio depending on your financial goal and risk appetite. For example, equity funds like ELSS might not just help you with saving taxes but in the long run might even offer you some long term capital gains. On the other hand liquid fund investments can come in handy when you are in dire need of cash during emergencies.

Avoiding risks in SIP investments is possible if you learn how to balance your portfolio through diversification.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.