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What is a Benchmark Risk?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 21 September 2016
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    Conjecture Corporation
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Also known as a benchmarking risk, a benchmark risk is a way of collectively considering all known risks that are involved with the acquisition of a mutual fund. Specifically, the benchmark addresses the risk of failing to earn a return on the investment in the mutual fund, taking into account all known risks associated with the options that are included in the fund. The cumulative risk is then compared to some type of standard or benchmark, such as the performance of the exchange where the options are traded. Assuming the benchmark risk is within acceptable limits, that is a strong indicator that the mutual fund will perform well enough to earn a decent return.

The determination of a benchmark risk measure is considered essential to not only investors, but also to the institutions that actively seek investors for a mutual fund. By assessing the overall degree of risk and comparing it to the risk associated with a similar standard or benchmark, it is possible to promote the fund as being at least as secure as similar investments, and possibly even more secure, since the benchmark volatility is so decreased in comparison to other investment possibilities. From this perspective, the proper calculation of the risk is essential to the process of attracting investors and keeping them involved in the fund over the long term.

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It is important to remember that regardless of the type and scope of assets that are used to back a mutual fund, some degree of risk will be present. Funds with a lower degree of risk will be highly likely to earn a small but consistent return over the years. Mutual funds that have a higher benchmark risk will normally be more volatile in nature, but also hold the potential for a significantly higher rate of return. The investment style of the individual investor will determine whether going with a mutual fund that carries a lower benchmark risk is the best strategy, or if going with the fund that has a higher degree of risk would be more in keeping with the goals of the investor.

Brokers are normally well-acquainted with the benchmark risk associated with any given mutual fund. This means that an investor who is interested in a particular fund can go over the various risk factors with the broker and decide whether to invest in that particular group of options, or look for something else. Brokers are usually happy to help investors find the right funds to match their needs, as well as remain informed on any factors that may have a lasting impact on the risk involved with the holdings in the mutual fund. By being aware of any shifts in the benchmark risk associated with the fund, it is possible for brokers to advise their clients on whether to hold the investment, or sell before there is a downturn and invest in a different fund.

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