People usually consider mutual funds to be a safe investment for those who have long-term goals. An excellent fund manager will select a balance of stocks and bonds with varying degrees of risk which generally keeps the principal safe and returns positive and growing. But can mutual funds go negative?
A mutual fund can go negative, but it’s almost unheard of and very rare. Under the rare market and management conditions, you could open your quarterly statement and find your assets at 0, which can mean a negative mutual fund. If it’s an investment, then you risk losing your money.
If you put all your money into a couple of stocks and those businesses close, you lose all of your invested capital. But, that is unlikely when you invest in a mutual fund because it’s structured to be low risk. So read on to find out how to avoid this.
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Here’s Why the Risk of Mutual Funds Going Negative Is Rare
Mutual funds usually consist of a diversity of many stocks and bonds of which each investor owns a small piece. Let’s take a closer look at why you most likely will not see a mutual fund go negative.
- Instead of buying shares of any one individual stock, fund managers invest the pooled money in a wide array of stocks, and each investor owns a piece of all.
- It is assumed all the companies will not fail and certainly not all at once. That is what would have to happen to the stocks for the mutual fund to go negative.
- When you buy bonds, you lend money to a company that promises to pay it back with interest, which fluctuates. The mutual fund manager invests your money in many different bonds, and when interest rates are high, the bondholder makes money.
- When interest rates are low, the bondholder makes less money. When interest is too low, the bondholder makes no money and can’t even sell the bonds, which results in the bond fund going negative.
- When interest rates are high, businesses tighten their belts and maintain their position, so you might not make as much on the stock investments. However, your bond performance balances that out.
- When interest rates are low, businesses invest in themselves, and your stocks provide you with healthy returns. The stock’s performance balances out the now lower-performing bonds.
Hence, the chance that all stocks and all bonds are on a collision course resulting in negative returns is negligible.
Three Ways To Earn Returns On Your Mutual Fund
When you invest in mutual funds, there are three different ways to make money.
Net Asset Value
The value of your investment after expenses are deducted is known as the NAV (net asset value). If it’s high, your fund value increases as well as the shares, which is what you anticipate happening when you invest in mutual funds.
Capital Gains
Securities in a fund will hopefully increase in value before you sell them. While it’s likely that not all your stocks and bonds in your portfolio will increase, that is the goal. When they sell for more than you paid for them, you realize a capital gain. Those capital gains, minus capital losses, are then distributed to the investors at the end of the year.
Dividends
You’ll want to look for a fund that pays dividends on stocks and bonds, as the shareholders are paid those dividends minus expenses.
These are important opportunities to secure a greater return on your investment. Ultimately, the fund manager’s choice of investment and the percentage of fees charged directly impact your rate of return.
Mismanaged Funds Are More At Risk to Go Negative
If you happen to see your funds go negative, it might be because your mutual fund is being mismanaged. Let’s take a look at the signs that your fund is mismanaged.
- The stock market swings up or down, but your funds should stay positive. A new president was inaugurated, China had an earthquake, somebody set up an embargo, an oil tanker springs a leak, and many other world events caused the markets to fluctuate. But mutual funds tend to ride these events, and if they don’t, your manager might be doing a bad job.
- A fund manager will anticipate those shifts, but a poor manager will not. However, many events within the mutual fund market may be more subtle but still impact the value of investments. Those events, subtle or not, are occurring daily, and a fund manager should know how to weather those shifts.
- An experienced manager will anticipate how the markets will react to any given event and make adjustments to protect assets or gain more profits, but a poor manager will not. Managing a mutual fund requires the endurance to work 70 hour weeks and read the financial climate changes as they happen. The fund manager can cause or prevent mutual funds from going negative.
- Before joining a mutual fund, learn everything there is to know about management strategies. Compare the top-performing funds and their investment style, and check historical performances. The expertise, style, and strategies of the fund manager are crucial, as the balance of diversification lies with fund sponsors and managers.
You May See Periodic Negative Returns
There may be many separate mutual funds under an investment firm’s umbrella, with each fund containing as many as one hundred or more different securities.
In any given quarter, some of those securities could show a low or negative return.
Any company can have a poor-performing quarter, but because a mutual fund contains a hundred different investments, chances are all 100 will not drop at the same time. Even if they do, unless interest rates are 1%, the bonds in your portfolio will balance the stocks, so your overall investment will grow.
When you see those negative returns, that is not the time to make rash decisions and sell your interest in the fund. Mutual funds are long-term investments, and they can weather the storms of the stock market and interest rate volatility.
Rely on Your Mutual Fund Manager When Negative Returns Occur
Your fund managers will know if a company won’t recover, and will reinvest your money in profitable companies.
During times when investors everywhere see losses on paper, the feeling is discouragement. But you wait because you want your money back. The only way to get your money back is patience, so you need to wait for the markets to recover and begin showing profits again.
As long as your fund manager is reputable and the world does not end, effective mutual fund strategies will prove profitable long term for conservative investors. Mutual Funds are low risk, and almost anyone with a job and a little disposable income can invest for their future security.
Stocks in Mutual Funds Can Go Negative, and That’s Okay
If you go up and down emotionally with the markets, you could be the most significant risk to your financial security.
We discussed the importance of patience when we see low or no returns on our investment statement. Ups and downs are routine, but investors sometimes panic and make costly investment mistakes when they perceive they’re losing money.
Behavioral Finance is the study of investor psychology, and a sub-topic is how psychology influences investor’s decisions.
For instance, an emotional reaction to negative returns might be to pull out of the mutual fund because 20 stocks out of a hundred have negative returns. This is known as risk perception, which is a fear that all investments will follow suit.
Major mutual funds offer a Systematic Invest Plan (SIP), and there is evidence that a SIP helps counter irrational investment behavior triggered by emotion.
Based on SIP, once you’ve made your initial cash investment into the fund, you can continue to add to the fund by making automatic deposits of a predetermined amount on a consistent schedule.
The amount and frequency of recurring investment deposits are determined between you and your fund management. As your salary increases, you can increase your investment deposits.
Your investments are now automated like your mortgage payment.
You are now consistently and automatically investing for your future, so that’s done. Let it take care of itself, and you can move on to other things that need your attention. You are less likely to react emotionally when not focused on the periodic fluctuations of the mutual fund.
A SIP could allow you to remove some risk from your mutual fund if a few stocks go negative temporarily.
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Conclusion
While some of the stocks within your mutual fund can go negative, it is unlikely the mutual fund as a whole will ever go negative. The only way your mutual fund could go negative is if it’s seriously mismanaged. Stay with the major players like Fidelity, T. Rowe Price, and Vanguard and ask them to set up a SIP for you, and the chances of your investment going would be nearly negligible.
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