Mutual Funds and Their Risks
Investing in mutual funds is a moderately safe way of growing your net worth, but such investments are not completely free of risks. Before you pick on any fastidious mutual fund for investment you should watch out for a few things.
Performance
The first thing you should look for is whether the mutual fund you are plotting to invest in is outperforming or under-performing with respect to the market. Excellent and safe mutual funds are those that consistently outperform the market. Changes in the net asset values (NAVs) of such mutual funds are consistently one step ahead of the market. For example, if the index that events market movements goes up, the NAV of most excellent and safe mutual funds will also go up at least as much as the market or even more than the market. On the other hand, when the market moves southwards, the NAV of most excellent and safe mutual funds will go down but such depreciation will be less than or at the most equal to the markets down passage. Unsafe or risky mutual funds are those where the opposite occurs when the market moves up, the NAV of risky or unsafe mutual funds may go up less than the market and may even go down despite a bull run in the market. Such under-performing mutual funds should always be eschewed when taking an investment choice.
Churn and earn
The next thing to watch out for is whether the mutual fund is undergoing too much churn and earn. This means you have to check whether too many transactions by the mutual fund are ensuing in higher fees or costs to the investor. In this perspective, the worst offenders are those mutual funds that have a lot of spurious churn. Every time a mutual fund buys or sells stocks, the broker or brokers it employs make a clean pile from the commissions. So, these brokers try to encourage a lot of churn or buying and selling of stocks by giving a cut to the mutual fund manager. Although direct incentive is unlawful, payment of soft money through a sponsored trip to Hawaii or letting the mutual fund manager have a swanky Wall Street office for $1 a month is not. The only loser in all this spurious churn is the investor, mainly in cases where the small print says that the investor will have to pay the brokers fees as well.
Lack of clarity
Mutual Funds that have brochure, annual reports or statements of additional in rank on paper in such a way that they are hard to know should also be avoided. The lack of clarity in their ID is nearly a sure sign of lack of honesty in their dealings or a lack of competency in managing funds both of which are strong reasons for avoiding them for investment purposes.
Risky and unsafe mutual funds are also characterised by having too many restrictions on how and when investors can sell or redeem their mutual fund shares. Mutual funds that have too long lock-in periods or those which slap a hefty exit load at the time of redemption should be eyed with suspicion and are likely to prove to be unsafe and risky.
Beware of scams
Finally, there are mutual funds that are outright scams. There have been reports of fund mangers selling stocks at prices other than what has been reported to the investor. For example, the fund manager may have sold stock at prices that prevailed before dying of the days trade although the investor is told that the transaction took place at dying prices which were lower. The manager then pockets the variation and with most such transactions involving large volumes, even a fractional price variation can lead to significant gains for the manger. Again the only loser in all this is the investor who gets small-altered by the mutual fund machinist!
Author: Jason Hanson
Condition Source: EzineArticles.com