The net assets of registered mutual funds worldwide registered in the US are about 24 trillion dollars, and investors have at least 7500 different funds to choose from. About 45% of US households invest in mutual funds. So, it is natural for one to wonder if mutual funds ever decrease in value?
Mutual funds can decrease in value. The value of the fund is determined by the collective value of the assets that the fund holds. Factors that might decrease the value of a mutual fund include certain fund management styles or the state of the market.
Before investing in a mutual fund, it’s essential to know the advantages and risks associated with multiple kinds of mutual funds. We hope to give you an overview in this article of how mutual funds can help you reach your financial goals despite the occasional decrease in value.
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Mutual Funds Can Decrease in Value and Then Rebound
Historically, mutual funds that decreased in value rebounded or regained their value. Robinhood cites two examples where this happened.
- During the 2020 pandemic, there was a downturn in the stock market, a volatile economic climate, retail losses, and unemployment. The market was in good shape going into the COVID-19 pandemic, and it quickly recovered within the year.
- Another example is the housing bust of 2007-2008, which threw our country into a recession. Not only did most investments lose value, but many investors lost everything. Some needed cash and were forced to sell at a loss. Those mutual fund investors that held on rather than take a loss recouped their losses in just under five years.
Five years is a nerve-wracking amount of time to suffer through. Although, it’s the smart move when your investment goal dates are five, ten, or twenty years out.
Management Style Influences a Decrease in Value of Mutual Funds
There are Active and Passive mutual fund management styles. The primary difference between the two is somewhat self-explanatory.
Active Management
Active Investing means that your portfolio managers and analysts are busy following and analyzing every asset in the fund for clues. The goal is to beat the average returns of the stock market.
Attentiveness to the slightest detail is necessary to predict price changes and take profitable advantage of fluctuations.
The assets are moved around more frequently, which means that more fees are associated with active management. The risk is higher as well because more decisions are being processed daily by the management team.
Active managers have more flexibility to buy, sell, and hedge because they don’t follow an index fund.
Passive Management
Passive management fees are considerably lower than active management because there is less fluctuation in assets. Passively managed mutual funds are desirable for those investing long term and those who are immune to the market fluctuations.
The choice of an index fund is tied to either Standard & Poor 500 or the Dow Jones Industrial Average as a benchmark. When those indexes go up, so does your index fund. Disposing of nonperformers and investing more in new stock ventures increases value.
These stocks, and the passive funds that follow them, use them as building blocks of the fund. The fund corrects itself and maintains stability. Investors always know what assets are in the fund.
A critical note about aggressive and passive managed funds: Aggressively managed funds rarely outperform passively managed funds.
Mutual Funds Can Decrease in Value Without Obstructing Your Investment Time Horizon
Your mutual fund advisors may inquire about your investment goals and time frame.
You might hope to have the down payment on a house in five years, save for college in fifteen years, and then retire comfortably in thirty years. These are investment time horizons, and under professional management, your portfolio will reflect the risk tolerance for each phase.
The longer the time frames, the more risk tolerance.
I hesitate to use the familiar set-it-and-forget-it phrase often associated with time horizon investments. However, while your investment is low risk, you need to maintain reasonable vigilance.
Can Open-End Mutual Funds Decrease in Value?
An open-end mutual fund is one of two categories.
Open-end funds are the category that most investors have in mind when they think of mutual funds. The management strategy used in open-end funds is quite different from the closed-end.
Open-end funds are those that are most convenient for the investor to buy. When you join one of these funds you will be issued a piece of the fund. It doesn’t matter how many other pieces have previously sold.
Your piece makes the fund bigger.
Closed-end funds are limited in the number of shares that result in higher fees. You can only buy into that mutual fund if a share is available, and the price is based on the total value.
There is a public offering, and when fully funded, the closed-end mutual fund is traded on an exchange.
The same formula for risk and return applies to open and closed-end funds. Closed-end funds often pay higher returns, but they are not as transparent, and the risks of decreased value are more significant.
Risks That May Decrease the Value of Mutual Funds
Risks that might decrease the value of mutual funds come in many forms.
- Inflation and high-interest rates can increase risks to fixed assets like bonds, but bonds with varying durations can minimize the risk.
- Businesses fail for many reasons, but you can protect your investment in stocks by diversifying segments and adding bonds.
- Volatile markets created by world events are difficult to predict. Market downturns should be factored into your decisions when selecting a mutual fund and management style like all risks.
Diversification and long-term investing are the best defense against the decrease in value of your mutual fund.
How Mutual Funds Work?
The Securities and Exchange Commission (SEC) defines mutual funds as SEC-registered open-end investments, which means you can sell your interest in the fund anytime you choose.
As an investor, you do not own any of the assets held by the fund, but rather the fund pools the money from many investors and purchases the stocks, bonds, securities, and other investments that make up the fund’s portfolio. Each investor owns a piece of the fund.
The fund assets grow, adding more value to the fund, which means the value of each piece owned by investors grows. Some of the assets in the fund may temporarily lose value, but likely not simultaneously because the investments are diversified over many sectors.
Those that lost value are balanced by those that increased in value. Overall, the fund itself makes money for the investors.
The risk of decreased value of the mutual fund as a whole arises with a volatile market downturn. You might see asset values drop so low that all your returns disappear, and a downturn in the markets can cause anxiety and sometimes result in rash decisions to sell.
Mutual funds are designed as mid to long-term investments.
History shows that if investors hold on to their shares in the fund, the fund will rebound if properly managed. SEC-registered managers manage mutual funds. It is through their expertise and strategies that the mutual fund is balanced.
Let’s take a closer look at how fund managers try balancing the funds.
- Managers might eliminate assets they don’t believe can recover.
- Buy more promising assets at the current low prices.
- Hold on to assets they know will recover and continue to increase in value.
By making strategic moves, the fund manager will minimize losses with preventative measures to protect assets.
There are times when you need to cut your losses. However, in a professionally managed diversified fund, those times should be rare. If you sell your shares while it’s down, you remove all chance of recouping your losses.
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Conclusion
Mutual funds can decrease in value, and all investments carry risk. Such funds are not get-rich-quick schemes but are low maintenance, low-cost wealth-building tools for goal-oriented investors dedicated to a time horizon.
Such investors have learned the secret of compounding. Their consistent investment deposits and earnings from their investment are reinvested back into the fund.
Their wealth grows exponentially throughout their investment. Again, the longer the term, the more significant the rewards.
Mutual Fund investors work on their plans, so they don’t have to plan on working forever.
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