For an investment mode that says “Mutual Funds are subject to market risk, please read the offer document carefully before investing”, it would be foolish of us as investors to not study the risks before investing in one of the most preferred investment types, which has, over time, become synonymous to profits and high returns.
Now while the risks associated with Mutual Funds investment remain same – Market volatility, fund manager’s experience , and economic condition as whole, etc -, what remains to be done on our part is to know the ways to measure risks so that we are able to make calculated investment moves.
In this article, we will be looking into the ways an investor can measure the risk that they would have to face when they start on their Mutual Funds journey, even if it is through one of the most seemingly safest modes – Systematic Investment Plan.
Without much delay let us begin with the indicators that would help you calculate the risk that you are taking.
It is a measure of a fund’s performance on a risk-adjusted basis. The measure takes the volatility of fund portfolio or security and then compares the risk-adjusted performance of the fund to the benchmark index. The excess of the investment return relative to the benchmark index return is the ‘Alpha’.
In simpler words, Alpha is noted to be representing the value which a portfolio manager subtracts or adds from the return from fund portfolio. 1.0 Alpha means that fund has outperformed the benchmark index by 1% and – 1.0 alpha means that there has been underperformance of 1%. From the investor’s point of view, the greater the alpha, the better.
Also known as Beta Coefficient, it is the measurement of volatility or risk associated with a portfolio compared to risk present in the whole market.
The Beta value is calculated using the regression analysis. You can think of it as the tendency of a fund to respond to market conditions.
A Beta value of 1.0 shows that the price of a fund would move as lock-step the market. A Beta value of – 1.0 shows that the invested fund will be a lot less volatile than the market condition. Likewise, Beta value of more than 1.0 hints at the fact that investment price will be more volatile than the market price.
It is a measure which represents the percent of a fund portfolio which can be explained by the movements in the benchmark index. The R-Squared numbers vary from 0 to 100. It has been observed that the R-squared value between 85 and 100 shows performance that is very tightly correlated with the index while avalue less than 70 doesn’t perform like the index.
It is advised that the investors should avoid the actively managed funds with a higher R-squared ratio, which are criticized to be very close to the index funds.
- Standard Deviation
It measures the data dispersion from the mean. The more the data is apart; the greater the difference is from the norm. Generally, standard deviation is a measure of volatility. A volatile fund would come with greater standard deviation.
It is advised that the investor should look at the standard deviation number to get an idea of how much return the fund is deviating from when compared to the expected returns on the basis of historical performance.
- Sharpe Ratio
It measures the performance of a fund after it has been risk-adjusted. It is measured through subtracting rate of return from investment’s rate of return and then dividing the number by industry’s standard deviation of the return.
The ratio gives investors the insight into whether or not the investment’s return is a result of wise investment or a result of excessive risk.
So here were the ways an investor can measure risks associated with their mutual fund investment. Now that you know how to calculate the number of risks that you will have to incur when investing in a specific mutual fund, it is time to start investing. Get in touch with our team of Finance experts to help choose the best risk-free Mutual Fund type.