Mutual Funds > Risk

Different Types of Risk


Depending on the kinds of securities it is allowed to invest in, a mutual fund is subject to one or more of the following types of risk.

Market Risk

The risk that the value of an investment will be adversely affected by the fluctuations in its market prices. These fluctuations may be the result of two other kinds of risk:

1. Unsystematic Risk – the variability in the stock’s price due to factors associated with the company. This type of risk can be minimized through proper diversification.

2. Systematic Risk – the variability in price related to factors that affect the economy and the financial markets as a whole.


Sector Risk

The risk which affects stocks in a particular industry or sector sector. Market or economic factors affecting that industry sector, could have an effect on the value of a fund’s investments.


Liquidity Risk

The risk which affects stocks in a particular industry or sector sector. Market or economic factors affecting that industry sector, could have an effect on the value of a fund’s investments.


Interest Rate Risk

The volatility of bond prices that results from changes in interest rates. Bond prices are inversely related to interest rates. When interest rates rise, bond prices fall and vice versa. Interest rates are affected by various factors such as the expected direction of inflation, monetary policy, political risk and other economic factors.


Credit/Default Risk

The creditworthiness of the bond issuer and its expected ability to pay interest and to repay its debt. A mutual fund can manage this risk by investing only in investment grade bonds.


Purchasing Power Risk

The risk that the rate of return on an investment will not be greater than the rate of inflation thus diminishing the value of your money, i.e., the value of your money in real terms will be less than the purchasing power of your original investment.


Currency Risk

Also known as foreign exchange risk – the risk that fluctuations in the exchange rates may negatively affect the value of the fund’s investment. This applies to mutual funds that are denominated in one currency but invest in instruments denominated in another.


Management Risk

A type of risk associated with all actively managed forms of investments. Investment decisions are made by portfolio managers who can and do make mistakes from time to time by selecting wrong issues or misallocating the assets of the fund. These errors in judgment can result in a fund’s underperformance, decline in value or even losses.