If mutual funds aren’t insured like bank deposits are, you could lose money. If a fund drops in value, it can be hard to tell if you can hang on while hoping that it’ll come back. It could drop a lot, and on sleepless nights, you might even wonder if it’ll drop all the way to zero. Once you understand how mutual funds work, you’ll know the likelihood of that.
How Shares Are Valued
Mutual funds set the value of a share at the end of every trading day. They do this by adding up the value of every investment they have and subtracting their expenses. Then they divide by the number of shares people like you have bought. The result is the net asset value, which means your share price. This price can go up and down based on what the assets are worth.
The “Erie Times News” points out that since the assets are the starting point for determining a mutual fund’s value, every single asset would have to fail completely for shares to go to zero. The paper adds that to qualify as being diversified, a fund must hold at least 16 equities. The odds against every one of these failing at once are strong. According to John Reese of The Guru Investor, the average mutual fund owns shares in 200 companies. All 200 would have to become worthless for a mutual fund to go to zero.
If the entire economy were to fail completely, it’s conceivable that every single company could fail with it. In that case, a mutual fund’s shares would certainly be worth zero. If it’s any comfort, all bank deposits would be worth zero too, even though they’re insured by the Federal Deposit Insurance Corporation. The FDIC would be broke just like everyone else in the economy. Even if you managed to get your money out of the fund before it collapsed, your money wouldn't have any value.
A fund could declare bankruptcy, but that would not mean its assets were worthless. Here’s how it works. A fund hires a company to manage its assets. If the managing company declares bankruptcy, the fund still owns the assets. According to CNN Money, the law says creditors couldn’t go after the fund’s holdings if the management company declared bankruptcy. In other words, the manager might be bankrupt, but the fund could still sell all its assets and distribute the money to shareholders.
- WealthManagement.com: Mutual Funds and the Crash
- GoErie.com: Mutual Funds Not Likely to Go to Zero
- CNNMoney: Could Your Fund Go Bankrupt? Why You Don't Have to Worry
- 20 Something Finance: How Is a Mutual Fund’s Share Price (NAV) Determined?
- Federal Deposit Insurance Corporation: Bank Closing Information
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.