If you are looking to achieve your long-term financial goals, a mutual fund will be the best choice. But like any investment, mutual funds also come with a certain level of risk.
When you invest in mutual funds that purchase fixed-income securities such as bonds, debentures or other debt instruments, you may face credit risk.
What is credit risk?
Investing in a mutual fund that purchases bonds, debentures, or other loans issued by corporations or governments involves a risk. There will be a possibility of losing the invested capital or the expected interest earnings. This is known as credit risk.
How to avoid credit risk?
To avoid this risk, there are several strategies that you can follow. They are:
Conduct thorough research
To avoid credit risk, the first step is to conduct thorough research before investing in a mutual fund. In doing so, you should research the investment strategy of the mutual fund and the types of fixed-income securities it invests in.
Additionally, you should research the credit rating of the issuers of the debt instruments held by the mutual fund. By doing this, you can determine the creditworthiness of the issuers and the level of risk involved.
Invest in high-credit quality bonds
Another way to reduce credit risk is to invest in high-credit quality bonds. When you invest in high-credit quality bonds, you are buying bonds that are issued by companies or governments with a good track record of paying back their debts. Furthermore, these entities have been given good credit ratings by credit agencies. By investing in these bonds, you can reduce the risk of loss.
Diversification
Diversification is a proven strategy to reduce risk in investing and increase the chances of achieving your investment goals. When you invest your money in different types of mutual funds that focus on different fixed-income securities and issuers, you are diversifying your portfolio.
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By doing this, you are spreading your risk across multiple investments. If one of the issuers defaults on their payment, the impact on your overall investment will be lower. Because you have other investments that are not affected.
Monitor your investments
After conducting research and diversifying your portfolio, it is essential to continue monitoring your investments. By doing so, you can keep track of the creditworthiness of the issuers of the debt instruments held by the mutual fund. This will help you to identify any potential risks that may arise and take the necessary actions to minimize their impact on your investment.
Overall, credit risk is a significant concern when investing in mutual funds that hold fixed-income securities. By employing the above strategies, you can reduce your investment risk and make good investment decisions for your future.
