The Inherent Risks of Growth Funds

Growth funds are a type of stock mutual fund that many investors like to invest in. This type of fund carries with it some inherent risks that you need to understand before getting involved. Here are the basics of growth funds and what risks come with them.

Growth Fund

The growth fund is a mutual fund that invests in growth stocks. The mutual fund will collect money from investors and use that money to purchase stocks that they decide on. The fund manager will spend a lot of time doing research on individual companies in order to identify patterns of growth. For example, if they see a company that has exceeded projected sales revenue in consecutive quarters, they might decide to purchase stock in the company. The fund manager is trying to provide capital appreciation for the mutual fund above anything else. This type of fund can post some significant gains on an annual basis. However, with this potential for growth comes some risk as well. Here are a few of the risks associated with growth funds.

Volatility

Growth funds are notorious for being extremely volatile. One year, the fund might post a gain of 30 percent. At that point, you are extremely happy with your investment. Then the next year comes along and the fund loses 10 percent for the year. Then you might start to reconsider leaving your money in this type of fund. Many people will sell their shares after a large loss like this. In order to invest in a growth fund, you are going to have to have a high tolerance for volatility. You need to be fine with some great years and some really bad years as well.

Timing

When you invest in a growth fund, you will also have to deal with timing risk. Since you are investing in a fund that is extremely volatile, there is a chance that you could enter the fund at the wrong time. In our last example, you might have bought your shares after the 30 percent gain in a year. Then you immediately have to suffer through a losing year. In order to make this type of investment work, you will have to be able to stay on board for a long period of time. For example, you might want to plan on sticking with a fund for a minimum of five years before selling your shares. Otherwise, you run the risk of getting in and out at the wrong time and costing yourself a lot of money.

Over Paying

Another problem with growth funds is that they could potentially overpay for certain investments. Many fund managers that want to get involved with companies that are poised for growth might be willing to pay a premium to secure shares in the company. When this happens, the fund will be purchasing fewer shares overall. This increases the risk for the fund by lowering the amount of securities that it holds.

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