Are Mutual Funds Safe Against a Bad Stock Crash?

90 million individuals owned mutual fund shares in 2011.

90 million individuals owned mutual fund shares in 2011.

The U.S. Securities and Exchange Commission advocates a "don't-put-all-your-eggs-in-one-basket" approach to investing. This strategy, commonly referred to as diversification, helps reduce your risk of loss by spreading your risk over several different investments. That's one of the primary draws of stock mutual funds. With a single investment, you get an instantly diversified portfolio of stocks. But while diversification reduces your risk, it does not eliminate it.

Broad Declines

A bear market is marked by general investor pessimism and typically involves a broad decline in stock prices across the board, although the stocks of some companies might buck the trend and rise in price. Your stock mutual fund's net asset value is determined each day after the market closes. If the total market value of the stocks in your mutual fund's portfolio has declined, that decline will be reflected in the the fund's net asset value.

Investment Objectives and Strategies

Each mutual fund is required by law to state its investment objective in the fund's prospectus. The fund manager is constrained by this objective regarding the types of transactions he can make. A fund's stated objectives and strategies might require the fund manager to keep a specified percentage of the fund's assets invested in stocks. This might prevent the manager from moving the assets into safer, cash or cash-equivalent investments during periods of broad decline.

Sector Funds

Some mutual funds invest in the stocks of companies that are involved in specific industry sectors, such as energy, transportation or precious metals mining. Others might invest only in specific international regions. While these funds can perform admirably when their economic sector is flourishing, they have little flexibility to avert losses during periods of economic decline in that sector.

Risk vs. Reward

There's no such thing as a 100-percent safe stock investment, so there's no such thing as a 100-percent safe stock mutual fund. All mutual fund investments involve some level of risk. If there is a bad stock crash, you could lose some or all of your investment. One rule for mutual fund investing is: the greater the reward, the greater the risk; but the flip side is not always true. Greater risk does not necessarily translate into a greater potential reward. You can take great risks for very little reward.

 

About the Author

Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.

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