Feb 13, 2014: A common notion is that if you work hard at your job, save diligently and invest your hard earned money in a well diversified portfolio which promises an average return of at least 8% on the long run, your financial future would be secure. There are many real life stories that have proven the viability of this concept. But that does not guarantee anything. No one has a clue about what the future holds.In a natural progression, a thoughtful investor would wonder about the reliability of investing instruments present in his portfolio.
A mutual fund is a very popular investing instrument. Every year millions of Americans invest their earnings in mutual funds with the hope of earning good returns. In that context, let's examine the worst case scenario of money invested in a mutual fund.What happens to your money if a mutual fund goes out of business i.e. the fund goes belly up?
Vain optimists might not like to think about this scenario, but death of a fund is inevitable even in a "booming" mutual fund industry. Every year there are several mutual funds casualties whereby funds liquidate their assets to shareholders. And such liquidations could cost you dearly.With an economic downturn, chances of mutual funds going bust are higher. Given this scenario, most would wonder about how to save their hard earned money in case one or more mutual funds went out of business.
Once you get a notice about the liquidation of a mutual fund, your best option is to bail out by redeeming your shares as fast as possible. Else, if you sit tight, the mutual fund's management company will send you a check for the value of your account on the fund's last day of operation. This check might be a pittance compared to what you could recover by an early redemption.
It is to be noted that if there is heavy early redemption from investors of a mutual fund (that is being liquidated), the fund's managers may be forced to realize gains by selling any winning stocks that are present in the fund's portfolio. In such a case, you could be slammed with a big tax bill if the mutual fund's gains from sale of winning stocks offset its losses. So it's a double whammy for the fund's investors. First, investors lose money since the fund has gone bust. Second, they need to shell out extra money as tax dollars to Uncle Sam.However there is some good news. If the mutual fund is in a tax deferred account like an IRA or 401(k), investors would not be affected by the above mentioned tax implications.
Upon contemplation, we feel that the best way of protecting yourselves is to stay away from funds that could go bust. But spotting such funds might not be easy. Experts suggest that you may use time tested methods like avoiding newbies, sticking with mutual funds from reliable and big companies (like Vanguard), and steering clear from too narrow sectors which implies shouldering higher risks.It'd be worth to do a thorough research and then invest in time tested, well diversified mutual funds from reliable companies. Else you might not only lose your money but also be hit with an extra tax bill.
If you have experienced or are knowledgeable about mutual fund liquidations, we'd be grateful if you could kindly leave your valuable feedback. Looking forward towards hearing from you :).
Image Source(s): iStockPhoto
