Look Beyond Returns? Learn How to Evaluate Mutual Fund Risk The "Right" Way in 2026

Mutual fund risks can vary widely depending on where and how a scheme invests. Looking at measures such as standard deviation, beta, Sharpe ratio, and Sortino ratio can help you assess this risk. Understanding these measures alongside the fund’s Riskometer can help you decide which mutual fund is ‘safe’ to invest in, as per its risk level and your investment goals and risk tolerance. 

Mutual fund returns can tell you how an investment has performed, but they don’t show the full picture. Two funds with similar returns may have taken very different levels of risk to get there. So how do you understand which mutual fund is 'safe' to invest in?

The answer lies in looking beyond returns. Checking the fund’s risk level, volatility, downside risk, and risk-adjusted performance can give you a better idea of how much risk you’re taking and whether it matches your risk tolerance. 

There are no ‘safe’ mutual funds to invest in. All mutual fund schemes carry certain risks, as mutual funds are market-linked investments. That said, risk levels can vary depending on the type of scheme, its underlying investments, and market conditions.

Here are some of the key risk factors you should keep in mind when evaluating mutual funds: 

Looking only at returns may not tell you how much risk a fund took to generate them. A more useful evaluation method is using risk-adjusted return ratios with factors such as your own risk appetite, investment horizon, and financial goals.

Here are six commonly used ratios that can help you understand if mutual funds are safe to invest in as per your risk tolerance: 

1. Standard Deviation

Standard deviation tells you how much a fund’s returns have historically moved around their average return. The wider these movements, the higher the fund’s historical volatility.

• A higher standard deviation indicates larger fluctuations in returns.
• A lower standard deviation indicates relatively smaller fluctuations.

When comparing funds, standard deviation is generally more meaningful when you look at schemes within the same category and over the same period.

2. Beta

Beta measures how much a fund has historically moved relative to its benchmark. It can help you understand how sensitive the fund has been to movements in the broader market.

• Beta of 1: The fund has historically moved broadly in line with its benchmark.
• Above 1: The fund has shown greater sensitivity to benchmark movements.
• Below 1: The fund has shown lower sensitivity to benchmark movements.

Beta is a relative measure, so remember that it should not be used alone to decide which mutual fund is ‘safe’ to invest in.

3. Alpha

Alpha measures a fund’s historical performance relative to the return expected based on its benchmark-related risk. Unlike standard deviation or beta, it is primarily a performance measure rather than a direct measure of risk.

A positive alpha generally indicates the fund generated returns above those expected by the model, while a negative alpha indicates the opposite. Alpha is particularly relevant when evaluating actively managed funds, but historical alpha does not guarantee future performance.

4. R-Squared

R-squared shows how closely a fund’s historical movements can be explained by movements in its benchmark. It is expressed from 0 to 100.

A value closer to 100 indicates that the fund has historically moved more closely with its benchmark. A lower value indicates a weaker relationship. R-squared is also useful when interpreting beta - a fund’s beta may be more meaningful when its R-squared with the chosen benchmark is high.

5. Sharpe Ratio

The Sharpe ratio tells you whether a fund’s returns have been worth the overall risk taken. It compares the fund’s excess return over a risk-free return with its total volatility.

• Higher Sharpe ratio: Better historical return for the risk taken.
• Lower Sharpe ratio: Lower historical return relative to the risk taken.

It is most useful when comparing similar funds over the same period.

6. Sortino Ratio

The Sortino ratio also measures risk-adjusted returns, but it looks only at downside risk. Unlike the Sharpe ratio, it does not treat positive and negative volatility in the same way.

• Higher Sortino ratio: Better historical return relative to downside risk.
• Lower Sortino ratio: Lower historical return relative to downside risk.

This makes Sortino useful when you specifically want to understand how well a fund has performed considering its negative fluctuations.

So, is investing in mutual funds safe? It may not be entirely safe, however still you can pick funds that match your own risk tolerance. 

Using these quantitative risk measures can help you evaluate mutual fund risks the ‘right’ way. But how can you potentially minimise risks even further? You can try the following strategies to add further checks: 

1. Diversification

Invest in a mix of equity, debt, hybrid, and other types of mutual fund schemes that suit your risk tolerance, time horizon and goals. Spreading investments across asset classes and sectors may help reduce concentration risk. 

If one sector or asset class underperforms, better performance elsewhere in the portfolio may help offset some of the impact. 

2. Check Riskometer and Disclosures

Always review the scheme riskometer shown in the Scheme Information Document. It will show you at first glance the risk level of the scheme as well as its benchmark. This pictorial representation may help you decide which mutual fund is ‘safe’ to invest in as per your risk tolerance level. 

Also check the scheme’s portfolio disclosures, investment objective, asset allocation, and key risk factors. These details can help you understand where the fund invests and the specific risks your investment may be exposed to. 

3. Periodic Portfolio Reviews

Another way to manage mutual fund risks is to review your investment portfolio periodically - typically every 6-12 months if you’re a long-term investor. Reviewing helps because sometimes market rallies can push your equity allocation higher than the target figure, increasing potential risks. 

When you review periodically, you can rebalance if needed and ensure your overall risk stays within what you can manage. 

Which mutual fund is safe to invest in isn’t a one-size-fits-all answer. Ultimately, there is no completely ‘safe mutual fund to invest in’. Which fund may be suitable depends on your risk tolerance and goals. 

The risk ratios outlined above may help you compare funds more meaningfully by showing volatility, benchmark sensitivity, downside risk, and risk-adjusted returns. When used together, they can give you a clearer picture of whether a fund’s risk profile matches what you are comfortable with. 

1. Which mutual fund is safe to invest in?

No mutual fund is completely risk-free. The level of risk depends on the scheme and its underlying investments. Check the fund’s Riskometer, portfolio, investment objective, and risk factors and choose a scheme that matches your risk tolerance and investment horizon. 

2. Are there any risk-free mutual funds?

As such, there are no risk-free mutual funds. Some types of mutual fund schemes may carry relatively lower risk exposure, while others have a higher risk exposure. 

3. What type of mutual funds are good for beginners?

That depends on your goals and risk appetite. Generally, simpler options like index funds or balanced funds may be easier to start with due to their potentially diversified portfolio and simple structure. 

4. Is investing in mutual funds safe?

Investing in certain types of mutual funds (like debt funds) may be relatively safer than more volatile and risky options like equity funds. However, you should understand that mutual funds are market-linked investments and carry varying levels of risk. They are regulated by SEBI and professionally managed, but this does not guarantee returns or protect against investment losses. 

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