High-Risk vs Low-Risk Mutual Funds
Risk is essential to investing; no discussion of returns or performance is complete without at least mentioning the risks involved. The difficulty for inexperienced investors, however, is determining where risk genuinely sits and what the variations between low and high risk are.
Because of the importance of fundamental risk to investing, many novice investors believe it is a well-defined and measurable concept. Unfortunately, this is not the case. As strange as it may seem, no one can agree on what “risk” implies or how it should be quantified.
Volatility has long been used by academics as a risk proxy. To some degree, this makes complete sense. The volatility of a number is a measure of how much it may change over time. The more options there are, the more probable it is that some of them will be terrible. Even better, volatility is quite simple to quantify.
Volatility, however, is a poor risk indicator. While a more volatile stock exposes the owner to various possibilities, the likelihood of such occurrences does not necessarily change. Volatility is similar to the turbulence a traveler may experience on a plane—unpleasant, definitely, but unrelated to the risk of a tragedy.
A better approach to think about risk is as the chance or likelihood of an asset losing its value permanently or performing below expectations. If an investor buys an asset with the expectation of a 10% return, the risk of that investment is that the return will be less than 10%. This also implies that underperformance compared to an index isn’t always a sign of danger.
High-Risk Mutual Funds
A high-risk investment is one in which there is a high probability of capital loss or underperformance—or a comparatively high probability of a catastrophic loss. The first is self-evident, if subjective: You could consider it dangerous if you were informed your investment had a 50/50 probability of earning your desired return. Almost everyone would agree that it is dangerous if you were informed that there is a 95% probability that the investment would not yield the projected return.
Low-Risk Mutual Funds
Low-risk investing has a lesser stake by definition—either in terms of the money invested or the value of the investment to the holdings. There’s also little to achieve, in terms of future returns or long-term benefits.
Low-risk investment entails not only guarding against the possibility of any loss, but also ensuring that none of the possible losses are catastrophic. When investors believe that investment risk is characterized by a loss of cash and/or underperformance compared to expectations, it becomes much simpler to distinguish between low-risk and high-risk assets.
Further Key Takeaways
- It’s also crucial to think about how diversity affects the risk of an investing portfolio. Dividend-paying stocks of big businesses are, on average, relatively safe, and investors may expect to receive decent returns over a long period of time. However, there is always the possibility that a single firm may collapse.
- If an investor puts all of his or her money into one stock, the chances of a terrible event occurring are still low, but the intensity of the event is much higher. Holding a portfolio of ten such companies, on the other hand, reduces not just the danger of portfolio underperformance, but also the size of the entire portfolio’s potential.
- Investors must be prepared to consider risk in a broad and flexible manner. Diversification, for example, is a crucial aspect of risk management. Having a portfolio of low-risk assets that all have the same risk may be quite harmful.
When considering risk, investors must consider aspects such as time horizon, projected returns, and expertise. Overall, the longer an investor is willing to wait, the more likely he or she is to get the projected profits. There is a link between risk and return, and investors who want high returns must be willing to endure a considerably higher chance of underperformance. Knowledge is also important—not just in picking investments that are most likely to achieve their desired return (or better), but also in assessing the possibility and size of what may go wrong wrongly.
Frequently Asked Questions (FAQs)
Q. Is it true that mutual funds are high-risk investments?
Mutual funds, like other investments, have risk, which means you might lose money. Most mutual funds will fluctuate in value as the value of their assets rises and falls. A mutual fund’s degree of risk. A professional manager selects assets that meet the fund’s risk and return objectives.
Q. Is it possible to lose money in mutual funds?
There is no assurance that mutual funds will not lose money. Indeed, in extremely severe conditions, you may lose all of your money. As a result, it’s a good idea to learn how mutual funds function. Fund managers manage mutual funds, which invest in a broad range of equities, bonds, and commodities.
Q. Is it true that mutual funds are riskier than stocks?
Mutual funds are less risky than individual securities since they are diversified. For risk-averse investors, diversifying their assets is critical. Reducing your risk, on the other side, can restrict the returns on your investment.