A. Will I get cheated or lose all my money?
No. As simple as that. Mutual funds are regulated to very high standards by SEBI. They are run by professional managers, and subject to a great deal of scrutiny and compliance. They will typically invest only in companies that are listed on major stock exchanges, which are also regulated by SEBI. Investments stay in your name at all time, and all money transfers back and forth are through official banking channels. When you invest in a mutual fund, there is next to zero chance of falling victim to a fraud (unlike chit funds, pyramid investment schemes and other shady investment operators).
B. Could I lose some of my money?
Yes. Mutual funds investment in market-linked assets i.e. investments that fluctuate in value based on the stock and bond markets. Mutual funds either invest in debt or equities. Debt is less volatile but also returns less. Equities are more volatile in the short term, but also return more over the long term.
Here’s a chart that shows the relative performance of various mutual fund types – both debt and equity, in comparison to bank accounts and savings.
Pay attention to not just the returns but also the volatility i.e. how much the value fluctuates. When you make an investment, it is impossible to tell where the market is going to go next. So imagine if you had invested somewhere in 2007 or 2008. Look at what happens to your investments between 2008 and 2009. At the same time, also pay attention to what happens if you hold on to those same investments through that losing period in 2009, and stick around for the next decade.
So when you buy mutual funds, you could lose money in the short to medium term because of market fluctuations. Remember, that market fluctuations only cause paper losses i.e. if you don’t sell the mutual fund while it is down, you don’t actually lose money, and you can hold on until it returns to its previous levels or better. Unlike individual company stocks or bonds, which can declare bankruptcy or default, mutual funds benefit from diversification (i.e. buying many stocks or bonds in a basket), so it’s rare that you ever experience permanent loss in a mutual fund.
Now even though you can see that equity funds give higher returns in the long run, not everyone has an investment horizon of 10 or more years. Furthermore, not everyone is comfortable with or financially able to suffer short term shocks in wealth. The investment plan that’s best for you is one that lets you sleep at night, and one that you can stick to through the market ups and downs. So ideally you should blend 4 – 6 different debt and equity funds to get the level of risk & return that is right for you. The combination of mutual funds that is most suitable for your own unique situation depends on a variety of factors including how long you can stay invested for, how stable your earnings are, how comfortable you are with fluctuations in your wealth, etc.
You can check out my website, Savvy Investments, and get a free customized recommendation for a portfolio of mutual funds, that is designed keeping in mind your investment horizon, your risk appetite and other factors. Our fund selection methodology is based on Nobel prize winning research, with rigorous back testing of over 15 years of mutual fund data to ensure that we pick the best performing funds for you. If you like the service you can also invest in all your funds from our single platform.