How Safe Are Mutual Funds

by Neal Frankle, CFP ®

Smart investors always ask how safe their money is. And when it comes to fund investing, the answer is a bit surprising. Just how safe are mutual funds? Let’s find out.

First, keep in mind that “safety” means different things to different people. When it comes to mutual funds, there are 3 or 4 ways to define safety. Let’s go through them one by one.

1. Is Your Mutual Fund Insured?

Nope. Your mutual fund isn’t FDIC insured or by anyone else. Your principal fluctuates in value. That means you might end up with less money than you started with. If that happens, it’s a bad vibe but it is part of the game. Expect fluctuations.

2. Is Your Brokerage Account Insured?

Usually, the answer is yes. Most brokerage accounts have SIPC* insurance (Securities Investor Protection Corporation). This insurance covers you for up to $500,000 (including $100,000 or $250,000 in your cash accounts depending on your custodian). This coverage is per account and not per household. That’s good. In addition, some custodians purchase more coverage and extend your SIPC insurance into the millions. Again, check with your custodian to be sure.

But keep in mind that the coverage replaces money and securities that go missing due to theft or failure. This does not cover market fluctuation.

3. Can your broker steal your money?

Yes. Your broker could forge your name (a felony last time I checked) and steal you blind. You’d then have a SIPC claim and your broker would go to the slammer. This happens once in a while but not too often. When it does the brokerage firm usually makes the investor whole rather than waiting for the SIPC to pick up the pieces. That’s not because they are altruistic. It’s because they don’t want the word to get out that they employ thieves and they don’t want you to sue them. Just sayin’.

4. Can the mutual fund manager steal your money?how safe are mutual funds

If he or she did, you would probably be covered by SIPC. But it would be hard for a manager (or anyone else) to steal money from your account (unless they forge your name as I said). You see, in most cases, your mutual fund or manager doesn’t even have your money. Here’s what I mean.

In most cases, your money is held by a third party trustee. The mutual fund manager tells the third-party administrator what to buy and sell and they execute the trades. This acts as a “Chinese Wall” between your money and your mutual fund. You should read your mutual fund prospectus to find out how it works specifically.

Bottom line? Yes. Your mutual funds are safe. They will fluctuate in value but don’t worry about losing value due to improprieties. Your time is better spent making sure you have the right investment strategy.

*SIPC

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{ 1 comment… read it below or add one }

Jose March 28, 2013 at 1:48 PM

Mutual funds are generally safe. The funds that aren’t are hedge funds (as if the average individual can even afford to get into them). there seems to be a never ending stream of hedge fund managers being marched off to jail. To make it even more interesting there’s even an article on bloomberg from last year on how to run your hedge fund from a jail cell! It was written tongue in cheek.

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