There can be many reasons for the loss of mutual fund such as; mutual fund not performing well due to adverse market conditions, not diversifying investments in different sectors, credit risk, impact of inflation and liquidity problems etc. There are many disadvantages of mutual funds.
If you also invest in mutual funds or are thinking of investing, then you should read about all these disadvantages of mutual funds carefully so that you can avoid losing your mutual fund investment.
(1) Disadvantages of Market Risk in Mutual Funds
The first disadvantage is related to the market risk of mutual funds. This happens when the market changes and the price of the mutual fund also changes. For example, if the stock market falls drastically, the price of the mutual fund may also fall.
Therefore, to avoid market risk, it is very important that investors keep proper diversification in their investment portfolio, so that they can avoid the loss of a single investment.
Apart from this, planning for long term investment is also important to avoid market risk. For example, if an investor invests in his mutual fund for a long time, then he will have to suffer less loss due to market fluctuations in the short-term.
(2) Mutual fund investors have to depend on the management
Another disadvantage of mutual fund that is associated with investing in them is management risk. This means that the performance of a mutual fund depends heavily on the management of that fund.
- The manager’s own expertise, experience and knowledge have a great influence on the fund’s portfolio selection, investment strategy, stock selection and overall decision-making process.
- If there is a problem with the management of the mutual fund, such as a senior manager resigning or there is internal conflict within the company, this can have a negative impact on the performance of the mutual fund.
- Also, some mutual fund companies use aggressive investment strategies to improve their performance, which can increase your risk.
Therefore, it is important for investors to thoroughly understand the management team of the fund and their past performance before investing in a mutual fund. Investors should try to monitor their mutual fund investments regularly and closely observe the decision-making process of the management.
(3) Losses due to changing interest rates in mutual funds
The third disadvantage of mutual funds is interest rate risk. Interest rate risk occurs when the interest rate in the market changes. In such a situation, investors investing in mutual funds need to compromise with the risk.
- When interest rates rise in the market, the price of bonds and debt funds fall and this can cause losses to mutual fund investors.
- To avoid interest rate risk, investors should add equity funds to their portfolio as equity funds are less susceptible to interest rate fluctuations.
(4) Mutual funds are subject to credit risk
The next big mutual fund disadvantage is credit risk. Credit risk means that the credit-worthiness of some mutual fund companies is not completely good, due to which there may be credit risk in the investment of their funds.
- Mutual funds usually invest in corporate bonds, government securities and other debt instruments.
- If a company defaults and the value of its bonds falls, it can have a negative impact on mutual fund investors.
- Therefore, investors should understand the holdings of the fund thoroughly before selecting their mutual fund investments.
- Investors should invest in bonds and debt instruments of companies and governments with good credit ratings, which reduces credit risk.
- Apart from this, the past performance of mutual fund companies should also be evaluated thoroughly, so that investors can get accurate information about their credit.
(5) Mutual funds incur losses due to rising inflation
One disadvantage of investing in a mutual fund is that if inflation increases, the value of your investment decreases.
Inflation means that the price of goods keeps increasing with time. If you have invested in a mutual fund whose return rate is 8%, but at the same time the inflation rate is 6%, then your actual earnings will be only 2%.
Therefore, you should look at the inflation rate along with the return of mutual fund investment and then take your decision.
Know – How to invest in Mutual Funds?
Know – How to invest in SIP?
(6) Losses due to liquidity problems in mutual funds
The next big disadvantage of mutual funds is that some mutual funds may have liquidity risk, i.e. it may be difficult to sell the units you have purchased.
- Liquidity risk occurs when the money invested in a mutual fund is not available at any price and you need to sell your units.
- When you try to sell your units, you find that the fund has low liquidity and there is a problem in selling your units.
- There may be some reasons behind this, such as the value of the stocks or bonds invested in the fund’s portfolio falling, or many investors in that fund are trying to sell their units.
- In such a situation, investors may have to wait for some time to sell their units, or they may have to sell their units at a lower price.
- Therefore, investors should also be aware of the liquidity of the fund before investing in a mutual fund.
(7) Concentration risk in mutual funds can lead to losses
The seventh disadvantage of mutual funds is concentration risk. This is a situation where a mutual fund portfolio is overly invested in a specific sector or company. If this happens, then if that sector or company is not performing, then the overall performance of the fund can be adversely affected.
(8) A mutual fund company must comply with the regulations of the regulatory authorities.
The next disadvantage of mutual funds is regulatory risk. This means that the mutual fund company has to work according to the instructions of the regulatory authorities for the investor.
Regulatory Authorities such as the Securities and Exchange Board of India (SEBI) monitor mutual fund companies and ask them to make certain changes in their operations. If the mutual fund company does not follow the instructions of the regulatory authorities, then regulatory risk may occur.
(9) Losses due to taxation in mutual fund investments
Tax implications of mutual fund investments can lead to taxation risks. When an investor buys his mutual fund units, certain tax rules apply to him.
When you hold your mutual fund units, their value increases. When you sell them, that value is subject to capital gains tax.
The capital gains tax rate is determined based on the holding period. If an investor holds his mutual fund units for less than 1 year, then short-term capital gains tax is applicable.
And if he holds his units for more than 1 year, then long-term capital gains tax is applicable.
(10) Sometimes it becomes difficult to sell mutual fund units
The next big mutual fund disadvantage is redemption risk. This is a situation where it becomes difficult to sell the units of a mutual fund. This situation lasts until the mutual fund company is able to provide liquidity to sell the units.
Suppose there are many investors in a mutual fund who sold all the units together. In such a case, the fund company has to pay money to all the investors according to their shares.
Disclaimer: The content on this website is intended for informational purposes only and should not be interpreted as financial or investment advice. Engaging in stock market activities involves inherent risks, and outcomes can be unpredictable. While we strive to provide accurate and up-to-date information, we do not make any guarantees regarding the completeness or reliability of the content. Any investment decisions you make should be based on your own research and consultation with a qualified financial professional. We are not responsible for any financial gains or losses resulting from actions taken based on the information provided here. Always invest wisely and at your own risk.
