Understanding Risk and Diversification
When saving in mutual funds, it is essential to understand the relationship between risk and potential return. Generally, higher risk levels are associated with the possibility of higher returns over the long term, while lower risk levels prioritize capital preservation with more modest growth.
Investing involves risk.
Risk Categories (1 to 7)
Our fund offering is categorized into seven risk classes, ranging from 1 (lowest risk) to 7 (highest risk).
- Category 1 to 2 (Low Risk): Suitable for short-term savings (under three years). These funds, such as fixed income funds, typically exhibit stable prices with minimal fluctuations.
- Category 3 to 5 (Medium Risk): An option for those seeking a balance between growth and stability. This category often includes mixed funds (equities and fixed income) or diversified equity funds.
- Category 6 to 7 (High Risk): Aimed at long-term investors seeking maximum growth. These funds, such as sector-specific or concentrated equity funds, can experience significant price swings.
You can find the specific risk class for each fund in our fund list.
Measuring Risk: Volatility and Standard Deviation
We use several metrics to quantify risk:
- Volatility: A measure of how much a fund’s returns vary over time compared to its average. It is typically calculated based on weekly returns over a five-year period.
- Standard Deviation (Total Risk): This figure indicates how much the fund’s annual return typically deviates from its average annual return. For instance, a 20% standard deviation means you should expect returns to vary by that amount above or below the average.
Strategies for Risk Management
1. Diversification
Spread your risk by investing across different regions, asset types, and industrial sectors. If one area underperforms, another may provide stability or growth.
2. Time Horizon
Your investment horizon is a key factor. In the short term, market volatility can lead to temporary losses. However, the stock market has historically provided more stable returns over longer periods.
3. Monthly Savings
By saving a fixed amount each month, you buy units when prices are both high and low. This “dollar-cost averaging” effect smooths out the impact of market fluctuations over time.
Common Types of Financial Risk
| Type of Risk | Description | Impacted Funds |
|---|---|---|
| Market Risk | General market decline affecting asset prices. | All funds, especially equity funds. |
| Concentration Risk | Risk from holding a narrow selection of assets. | Sector funds and concentrated portfolios. |
| Currency Risk | Fluctuations in exchange rates affecting value. | Funds holding foreign assets (e.g., USD, EUR). |
| Political Risk | Instability in specific regions or countries. | Emerging market funds. |
| Credit Risk | Risk of an issuer defaulting on payments. | Primarily bond and fixed income funds. |
| Interest Rate Risk | Price changes driven by shifting market rates. | Bond funds. |
| Liquidity Risk | Difficulty selling an asset quickly at a fair price. | Small-cap or specialized sector funds. |
