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If you have a long-term horizon, should you invest in risky mutual funds?

Mutual funds do not guarantee any returns. Your returns from them are entirely dependent on the performance of the investments made by them

ET Online|
Nov 26, 2019, 12.23 PM IST
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I am young, I can take high risk.

I want to invest in small cap schemes since I have a very long investment horizon.

These are some of the standard responses ETMutualFunds.com receives when we ask our readers about their risk profile. We know that many investors, especially the newcomers to mutual funds, tend to get carried away when the market is on a roll. That is why we want to be doubly sure that they have the necessary risk appetite to opt for riskier mutual fund schemes like mid cap and small cap schemes.

Why risk matters?
For many investors, risk is just an abstract idea, amplified by the standard disclaimers made by mutual fund houses: mutual fund investments are subject to market risk. Please read… Well, don’t take the disclaimer for granted. Mutual funds do not guarantee any returns. Your returns from them are entirely dependent on the performance of the investments made by them. In other words, if the investments lose value sharply, you would lose your capital.

Now, imagine this scenario: you are a 30-year-old investor in a small cap scheme. Your scheme lost 50% of its value in a year. Would you be okay with that? Some of you might be okay with that if the loss is on the profits made already. But you would get worked up if the 50% fall wiped out a part of your initial investments.

Make no mistake. The risk is about losing your capital or initial investment. Would you be okay with a temporary loss of 50 per cent? How about 75%? In theory, you can lose your entire investment in the market.

Can time heal?
Now, let us move to the next scenario. What if your small cap scheme lose value further by 10% next year? And gains 15% the next year? Would you be okay with the zigzag movement? Of course, some investors won’t mind the volatility because they know how to handle it. However, many investors would prefer a rather steady movement. Why?

Well, that is their mental makeup. These investors are mentally not prepared to handle the ups and downs in their investments. They have not imagined the scenario when they started investing.

But will these investors react if you remind them about their long investment horizon? Most mutual fund advisors and financial planners say it doesn’t help much. In theory, if you have time in hand, you can recoup your losses and make handsome gains from equity investors. However, the theory is of little help when the going gets very tough, claim advisors.

Do you really need them?
Some financial planners point out that some investors won’t even need the extra returns to meet their financial goals. The basic idea of taking extra risk is to earn extra returns – so that you can meet your long-term financial goals easily. When your asking rate is 12%, why would you take extra risk to earn 15%, asks a financial planner.

He points out that avoiding unnecessary risk is an extremely important part of financial planning. If you fail to continue with your investments that you have drawn up after spending weeks or months, it is not just a waste of time. It would also result in losing an opportunity to make money.

So, do yourself a favour. Stick to mutual fund investments that are in line with your risk profile.

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