For countless investors in India, the primary question is not about finding the right level of risk for their financial goals. Instead, the burning query is often, "Which mutual fund will give me the highest returns?" The dream scenario, as one expert puts it, is the financial equivalent of enjoying gulab jamun every day while still managing to lose weight—seeking high returns with low risk and no losses whatsoever.
The Reality of Risk: It's About Behavior, Not Labels
When you invest in mutual funds, avoiding risk is impossible. The real opportunity lies in understanding it and selecting the kind of risk that matches your objectives and temperament. At Value Research Fund Advisor (VRFA), the focus is not on eliminating risk but on making it visible, comprehensible, and manageable for investors.
Many treat risk as a simple label—"Low," "Moderate," or "High"—stuck on a fund's fact sheet. They assume a "Low" risk tag means safety and a "High" one promises spectacular gains. In truth, risk defines how your invested money behaves: how much your fund can decline, how frequently, for how long, and critically, what you are likely to do when that decline happens.
Consider a typical flexi-cap equity fund. During a severe market downturn, such a fund could plummet by over 50% from its peak to its lowest point. The recovery to its previous high might take approximately three years. Imagine an investor who commits Rs 10 lakh to a solid flexi-cap fund at a bull market's start. In a subsequent deep correction, the portfolio's value could shrink to around Rs 4.3 lakh—a drop exceeding 55%. Over the next three years, the fund may climb back past the Rs 10 lakh mark.
The true financial damage often stems not from the market fall itself, but from the investor's panic midway through the cycle. Halting Systematic Investment Plans (SIPs) or exiting the fund near the bottom locks in permanent losses. The fund eventually recovers, but the investor does not. At VRFA, when suggesting an equity-heavy portfolio, this historical "normal fall" is factored in, and efforts are made to prepare investors psychologically before such events occur.
Equity vs. Debt: Two Sides of the Risk Coin
The Long-Term View on Equity Risk
Observing an equity fund daily is like watching a hospital heart monitor—it's a jagged, stressful line. Over a single year, it's normal for such a fund to surge 30% or drop 20%. However, extend the timeframe to 7–10 years, and those volatile lines smooth out significantly. Short-term noise fades, and the real peril shifts to not holding enough equity to outpace inflation over the long haul.
In simple terms, short-term risk is "my money may be worth much less at an inconvenient time." Long-term risk transforms into "if I avoid equity, my money may not grow enough." For perspective, Rs 10 lakh in a savings account at 4% interest grows to about Rs 15 lakh in 10 years. The same amount in a decent equity fund, despite its inevitable ups and downs, could reasonably grow to around Rs 31 lakh over the same period, based on historical equity returns. The lesson is stark: avoiding volatility at all costs can lead to long-term wealth erosion.
The Hidden Dangers in "Safe" Debt Funds
Debt funds often appear calm, leading investors to treat them like fixed deposits. This is a misconception. They carry distinct risks: credit risk, interest-rate risk, and liquidity risk.
Credit risk is the chance a bond issuer defaults. If a debt fund holds bonds from a troubled company, its Net Asset Value (NAV) can crash sharply in a single day. For instance, a fund with Rs 5,000 crore in assets holding 8% of its portfolio in a troubled issuer could see its NAV drop 6–7% overnight. An investor with Rs 10 lakh in such a fund could face an unexpected loss of Rs 60,000–70,000.
Interest-rate risk means existing bond prices fall when new interest rates rise, affecting long-duration funds. Liquidity risk occurs when many investors exit at once, forcing the fund to sell holdings at a discount. Consequently, VRFA approaches debt fund selection with extreme caution, prioritizing high-quality, shorter-duration options for capital preservation over chasing marginally higher yields.
The Biggest Risk Factor Is You
Here lies the most uncomfortable truth: the greatest risk in mutual fund investing is often the investor's own behavior. Buying a fund because a friend profited from it last year, stopping SIPs during market falls, or constantly chasing last year's top-performing category—these actions convert temporary market volatility into permanent financial loss. There will always be a gap between a fund's potential return and the return an average investor actually earns due to these behavioral pitfalls.
VRFA's core mission is to narrow this gap. Its model portfolios are designed not just for theoretical maximum returns but to be livable. They aim to stay within a loss range an investor can tolerate, match asset allocation with goal horizons, and prevent short-term money from entering long-term, volatile instruments. When markets tumble, VRFA communicates with subscribers, explaining the situation and reminding them of the risk they consciously accepted—a nudge often more valuable than any fund selection.
A Three-Question Risk Checklist for Every Investor
Before investing in any fund or portfolio, ask yourself three straightforward questions:
- How much can this investment fall? Study how similar funds performed in past crashes. A 60-70% decline, while unpleasant, is normal for an aggressive small-cap fund.
- How long can it stay down? Historical data shows some funds take about 35 months to recover from major drawdowns; others may need 5 to 6 years. If your financial goal arrives before that, this investment is unsuitable.
- What will I do if that happens? Be honest. If you know a significant drop will cause sleepless nights and likely lead you to sell, that risk level is not for you, regardless of what past return charts indicate.
This pragmatic approach is embedded in VRFA's methodology, which treats investors as emotional human beings influenced by WhatsApp groups, not as perfectly disciplined robots.
Ultimately, understanding mutual fund risk isn't about jargon. It's about accepting that you need equity for long-term growth, debt for stability, and behavioral discipline to bridge the two. Get this combination right, and you can harness risk as an ally. Your equity funds will fluctuate noisily, while your debt allocation and steady behavior keep your financial plan on track. For those who don't wish to make this their night job, services like VRFA exist to transform complex risk into a simple, actionable plan.
Returns are displayed on a fact sheet. Risk reveals itself in your heartbeat when markets crash. The clearer you are about the latter, the better you can enjoy the former.
(Sneha Suri is Lead Fund Analyst - Value Research's Fund Advisor)
Disclaimer: The recommendations and views expressed by the expert are their own and do not represent the views of The Times of India.
