Tags: Wealth Management, Investment Lesson, Mutual Funds, Stock market, Budget, Finance, Investing, Personal Finance, Investment
Article Summary
Risk-O-Meter is the visual depiction of risk and uncertainty in a mutual fund scheme and acts like a product label.
It is like a dial in a car dashboard with six levels of increasing risk, moving clockwise from low risk, moderately low risk, moderate risk, moderately high risk, to high risk and very high risk.
Risk-O-Meter is mandatorily required in all scheme documents like Scheme Information Document (SID) and investor communications, including brochures and advertisements.
It helps an investor understand the role of risk in potential returns, besides downside of returns and investment’s fit with financial goals.
When you buy household items like packaged food, besides the price, you examine the composition, expiry dates or best before date, besides any warnings regarding use. Manufacturers are required to disclose these essential details in the packaging. Similarly, for any form of investor communication and mandatory disclosure, mutual fund investments need to have a standard visual depiction of risk related to the particular mutual fund scheme. This is done through a Risk-O-Meter.
What is Risk-O-Meter?
Before you type words like “riskometer,” “mutual fund riskometer” and "riskometer of mutual fund" on your device, to search for more information, let us give you a quick and easy idea about Risk-O-Meter and how it helps investors.
Risk-O-Meter is the visual depiction of risk and uncertainty in a mutual fund scheme and acts like a product label for investors considering investment. This depiction is in the form of a car dashboard with six levels of increasing risk, moving clockwise. Risk-O-Meter needs to be mandatorily present in all scheme documents and investor communications, including brochures and advertisements.
RIsk-O-Meter’s six risk levels
At the end of mutual fund advertisements in radio, television and social media, the audience is informed that all mutual fund investments are subject to market risks. However, the degree of risk varies among different mutual funds. This is where “riskometer of mutual fund” or “riskometer” comes into the picture. The mutual fund industry regulator Securities and Exchange Board of India (SEBI) has classified 6 risk levels for “mutual fund riskometer”, as some people call it. The risk levels are as follows:
Low risk Such low risk funds offer low return but high safety of capital.
Moderate to low risk Such mutual funds carry higher risk than low risk mutual funds and hence, have the potential to provide higher returns.
Moderate risk Mutual funds falling under this category have a higher risk than moderate to low risk funds and consequently, can potentially deliver higher returns.
Moderately high risk Again, by taking higher risk than funds in the previous category, investors can improve their prospects of higher returns.
High risk These mutual funds typically exhibit high volatility and also have the potential to deliver high returns in the long term i.e., 8-10 years, or more.
Very high risk Returns from such mutual funds have the potential for highest possible fluctuations and in lieu of this very high risk, also have the prospect of delivering higher returns than funds with the high risk label.
An interesting aspect of “riskometer” is that both equity and equity-oriented hybrid funds and debt funds can have “high risk” and “very high risk” labels. This is because the factors considered for risk labelling are different for debt and equity funds.
For debt funds, major risks accounted for include credit risk, liquidity risk and interest rate risk with liquidity risk given the greatest importance. On the other hand, for equity funds, major risks accounted for are market capitalisation, volatility, and impact cost (basically liquidity of stocks with lower public float).
Risk-O-Meter’s Risk Labelling for Existing and New Funds
When a new fund is launched during a New Fund Offer (NFO), a risk level is assigned to a fund. Once can assess one’s risk levels and financial goals before deciding on whether to invest in the fund. The risk levels are evaluated on a monthly basis and get reflected in the fund documents with risk and portfolio disclosure happening on the websites of the fund house and mutual funds industry body Association of Mutual Funds in India (AMFI).
It is worth pointing out that any change in the risk levels can occur due to changes in the composition of investments in the fund’s portfolio. This will lead to a change in the Risk-O-Meter and needs to be conveyed to the investors.
How Risk-O-Meter Helps Investors
Role of risk in returns
Often, higher returns are an outcome of higher risk in the long term. “Mutual fund riskometer” can lay bare such a possibility. This can be critical in longer term, higher risk debt funds.
Provides a true picture of the fund’s return downside
Potential investors can weigh the potential for returns against the risk and volatility involved.
Examine the fit with financial goals
Depending on factors like the time left for a financial goal, the amount of money required, an investor can evaluate whether the fund deserves to be earmarked for the goal.
To conclude, being well-informed about any potential investment’s track record is not just about its returns over time but also the level of risk assumed to achieve them. Risk-O-Meter empowers investors to take well-informed and better investment decisions.
FAQs
How can Risk-O-Meter be used in planning for financial goals?
For immediate and imminent needs arising in 3 months to 2 years, consider low and moderate risk funds. For medium term needs expected to arise in 4-6 years, consider moderate to moderately high risk funds. For major long term goals in the distant future, depending on risk appetite, consider high and very high risk funds.
Can the Risk-O-Meter of a fund change?
Yes, that is possible with changes in risk levels of investments assessed during mandatory monthly risk reviews. When that happens, the mutual fund needs to inform the investor through a communication and make the necessary changes in the Risk-O-Meter in scheme documents.
Disclaimer:
The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. All complaints regarding Mutual Fund can be directed towards visit www.scores.gov.in (SEBI SCORES portal). Readers are requested to make informed investment decisions and consult Chaitanya Financial Consultants – 9000628943 / mfd.mmr@gmail.com to determine the financial implications with respect to investing in Mutual Funds.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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