Complete understanding of risks and return expectations crucial for profitable investments in mutual funds, says expert

Investing in mutual funds offers the potential for attractive returns, but it's crucial for investors to remain mindful of associated risks. To effectively navigate various market cycles, understanding and addressing these risks is essential.

Prableen Bajpai, the Founder of Finfix Research and Analytics, underscores the interconnectedness of risks and returns in investing. She emphasises the significance of understanding not just return expectations but also the necessary risk exposure to attain those returns.

"Risk and return are two sides of the same coin. Depending on the market conditions, investors usually tend to focus on only one - in better times it is the returns which are in focus, and risk factors are ignored by investors, and in times when markets are witnessing a downfall, it is usually the risks which are highlighted.

So focusing on only one of them results in making decisions that are not optimal for the creation of any portfolio. Complete understanding of not only the return expectations but the risk which needs to be taken to get those returns is important," Bajpai said in an interview with CNBC-TV18.

Risk, in its simplest form, denotes the uncertainty and potential for losses inherent to any investment. While it cannot be entirely eliminated, it can be managed and optimised to align with one's investment goals.

When investing in mutual funds, investors encounter various risks, including market risk, credit risk, liquidity risk, fund selection risk, concentration risk, and interest rate risk.

Market risk, also known as systematic risk, cannot be diversified away. Bajpai underscores that market risks are influenced by a multitude of factors, impacting the broader market. These factors encompass inflation, economic recessions, political instability, and significant interest rate fluctuations.

Bajpai advises investors to tailor their investments to the appropriate time horizon and establish a well-balanced asset allocation to mitigate market risk effectively.