Canadian Securities Course (CSC) Level 2 Practice Exam

What disadvantage of mutual funds relates to the potential for volatility in the market?

1. Cost

2. Systematic risk

3. Short term unsuitability

4. Tax complications

The correct answer is: Systematic risk

The selection of systematic risk as the correct answer highlights a key characteristic of mutual funds, particularly in the context of market fluctuations. Systematic risk refers to the inherent risk that affects the entire market or a broad segment of the market, which cannot be eliminated through diversification. Mutual funds, like any pooled investment vehicle, are subject to this type of risk because they invest in a portfolio of securities that mirror the performance of the overall market or specific sectors. When market conditions deteriorate, they can experience significant volatility, leading to fluctuations in the value of the mutual fund shares. This means that despite the diversification provided by the mutual fund's holdings, they are still exposed to market-wide risks that can influence their performance. Understanding systematic risk is crucial for investors as it emphasizes that while mutual funds can spread out specific risks associated with individual securities, they cannot shield investors from broader market downturns. Thus, the inherent volatility of the market affects mutual funds directly, making systematic risk a notable disadvantage in unstable market conditions. The other options—cost, short-term unsuitability, and tax complications—do not directly relate to the volatility of the market in the way that systematic risk does. While each of these factors presents challenges to investors in mutual funds, they are