Risks of Mutual Fund Investing
- Mutual funds are not guaranteed securities, and they are subject to market fluctuation. In fact, during the 2008 financial crises, owners of stock funds saw their fund values plummet along with stocks of all varieties. Markets tend to move in tandem. When bond prices are rising, junk bonds usually rise along with AAA-rated bonds. When stocks are falling, blue chip stocks with above average earnings fall along with overvalued micro cap stocks. Thus, no matter how well a fund is managed, it is subject to rise and fall with the markets in which it invests.
- Not all mutual funds are the same. Each fund has a focus, and the fund manager is restricted by an investor agreement called a charter document. Aggressive growth funds focus on smaller companies that have strong growth potential. During bull markets, these types of funds can outpace other types of funds. However, during poor market conditions, they can plummet faster and are considered riskier than their competitors.
- Other funds attempt to balance risk with potential reward. A balanced fund, for example, invests in both stocks and bonds. Bond prices usually rise when stocks fall and vice versa. Likewise, big blue chip companies have a lower beta than many smaller companies. This means they don't climb as quickly during bull markets, but they don't fall as quickly during bear markets. Big cap stock funds that invest in blue chip stocks are considered moderately risky as are funds that balance between stocks and bonds.
- For people more concerned with capital preservation than growth, bond funds and money market funds offer a higher degree of safety. Bond prices can fluctuate in response to interest rates, but the bond's principal is guaranteed. In addition, bonds pay investors periodic interest. Money market funds invest conservatively, and while they are not 100 percent guaranteed, they rarely lose money.
