Mutual Fund Risks

The major risk when investing in a mutual fund is the risk of losing the principal due to a fall in NAV. There are many kinds of risks: interest-rate risk, market risk, and quality of securities, to name some.

Rising market interest rates tend to depress the stock market as well as that of bonds, resulting in a NAV fall in bonds and share funds. A fall in the markets interest rates turns out in a revaluation of share and bond prices (as in NAVs stock and bond funds).

The characteristics of securities determine the volatility in fund price changes. The stock fund that invest in small company shares and in emerging growth stocks have more price changes while in raise during the markets speculative periods, and a greater undergrowth in the same during the bear markets than the conservative income equity funds that invest in shares of larger and better established companies.

Some small company funds invest in small stocks of doubtful value what brings some losses to their funds. Standard & Poor?s rating services known by its ratings of individual bonds has introduced a rating service for mutual funds. The fund is either rated with a select rating or is simply not rated.

With all the banking mistakes and flaws in the past and the staggering financial situation of some savings and loan associations in the U.S., the investors are really concerned by the risk of insolvency of mutual funds. A mutual fund always can “go under”, but probabilities that this happens is very small.

The difference between banks and mutual funds is that mutual funds are constituted differently which reduces flaw and loss risks do to frauds. Mutual funds are typical corporations that have shareholders as owners.

A managing company that has nothing to do with funds is hired by shareholders to manage the funds daily operations. Although a managing company supervises the funds investments this does not own any of the assets (investments). A custodian, be it a bank, keeps the investments.

That is why, if a managing company gets into financial problem, this will not affect the funds investments. But even with these supervisions and balances, there is always a fraud possibility.

SEC liquidated two mutual funds that were quoted in financial newspapers along with other funds, but ended up being ghost funds.

A transfer agent keeps the shareholders accounts and also supervises their acquisitions and redemptions. Besides, the managing companies take fidelity bonds, a type of insurance to protect fund investments against embezzlement or fraud that any employee could try to carry on.

Along with safeguards other two factors differentiate mutual funds from corporations such as banks and savings and loan associations:

Mutual funds must be able to redeem shares on demand, which means that a part of their investment assets must be liquidated.

 Mutual funds must be able to value their investments at the end of each day, what is known as marking to market. This market investment value adjustment reflects the daily gains and losses.

For these reasons mutual funds cannot undercover their financial problems as easy as a bank or a savings and loans association could do so. SEC regulates mutual funds, but fraudulent operators always search the way to introduce themselves in an industry. Although the risk of fraud will always be there, it is not greater in the mutual fund industry than in any other.

Above all, you should have in mind that you could lose money through fund acquisitions whose investments have a poor market performance.