Why are Mutual Funds considered risky even when they diversify risk?


Mutual Funds Sahi Hai?

Mutual funds help investors diversify risk by spreading their portfolio across many securities from different industries as opposed to investing directly in stocks of few companies. With a small amount of money, an individual investor can diversify his portfolio across many industries and companies by investing in a mutual fund.  

There are two kinds of risks that affect any asset class: Systematic or Market risk and Unsystematic or Specific risk. Specific risk affects a company or industry and can be diversified away by holding a well-diversified portfolio of stocks from different industries. But Systematic risk cannot be diversified away since it affects all stocks across industries. While mutual funds help us diversify the Specific risk present in individual stocks or industries, they are still exposed to Systematic risk or uncertainty that affect the whole market and cannot be diversified away.  

For instance, air-line stocks are prone to rising crude oil prices while agro stocks are prone to weak monsoon. These are examples of Specific risk and with a diversified portfolio, one can minimize the impact of such risks. But stocks from both industries are prone to macroeconomic factors, geo-political instability, global financial crisis, currency fluctuations etc. These are examples of Systematic risk that will always remain even if a mutual fund is holding stocks from varied industries. 

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