Mutual Fund Risk: Understanding the Real Risks Behind Diversification

With mutual funds, "risk-free" is a term that gets used frequently. However, even though mutual funds are fairly safe investments, they are not risk-free. Here are a few things to consider about the risk associated with mutual funds.

Mutual Fund Risk

A mutual fund is an investment vehicle that is highly diversified. When you invest money with a mutual fund, the fund manager is going to use it to buy many different securities. For example, they will buy hundreds of different stocks in different sectors. They might even buy some stocks and some bonds to provide even more diversification. However, just because something is diversified does not mean that it is risk-free.

Risk Mitigation vs Elimination

It is important to understand the difference between risk mitigation and risk elimination. With a mutual fund, you are mitigating your risk by spreading it out over many different investments. Risk elimination would mean that there is no possible way that you could lose your initial investment. With a mutual fund, theoretically the stock market could completely crash and every stock in the mutual fund could be worthless. In that case, you would completely lose your initial investment, and there would be no way to get it back.