Q:If stock market crashes then equity mutual funds also crash. So how are mutual fund safe?
A: This is a common question and it is very important to understand the answer. This will ensure that you approach mutual fund investing with your eyes open.
First let’s look at the facts:
#1. Equity mutual funds are a way for you to invest in stocks, so the performance of the stock market will have a large bearing on the performance of your investment.
#2. The stock market will go up and down and so will the value of your equity mutual funds. However, over the long term, investments in equities as an asset class provide inflation beating returns. This is explained in a previous article.
Why are mutual funds considered safer than investing directly in Equity?
Besides the market risk explained above, an investor also encounters 2 other risks and, this is where mutual funds help you:
#1. Risk of making bad decisions
This is especially true of investing in stocks. People lose their life's savings investing in stocks based on tips. Mutual funds, on the other hand, have professional fund managers assisted by research teams whose sole job is to make these decisions.
You get the benefit of their knowledge & experience. In fact, good mutual funds have a track record of giving you better return than the market. (Read: what is better - investing in mutual funds or directly)
The other way mutual funds help you avoid bad decisions is through the diversity they provide. They even out the risk associated with individual stocks doing badly.
#2. Risk of losing money to fraud
Mutual funds are tightly regulated by SEBI, so there is no chance of losing your money to fraud.