What Happens If My Mutual Fund Company Goes Broke?

Filed in Money by on June 5, 2014 0 Comments

Defenition of risk- mutual fundSome of the people I assist with financial planning have been astute enough to ask the following question:

“So you recommend Vanguard as an excellent mutual fund company to use for my investments. Well, what happens if Vanguard goes bankrupt? Shouldn’t I spread my money around to more than one mutual fund company? You’ve told me I should diversify my investments among literally thousands of investments in stocks, bonds, etc. by investing in index funds, because any individual company is susceptible to unknowable risks such as fraud, accounting irregularities, and simple mismanagement. Shouldn’t I also diversify my money among mutual fund companies for the same reason?”

Like I said, good question.

Here is why diversifying among mutual fund companies, more specifically called “investment companies,” is generally considered unnecessary. When you invest in a mutual fund with an investment company such as Vanguard, you actually become the legal owner of shares in the individual mutual funds you invest in, such as “Total Stock Market Index Fund,” “Emerging Markets Fund,” or whatever. Under the Investment Company Act of 1940, each fund is set up as an individual legal and corporate entity, with its own board of directors. If the investment company (such as Vanguard, Fidelity Investments, T. Rowe Price) were to file for bankruptcy, its creditors would not be able to touch your fund’s assets. The fund’s directors would, presumably, immediately hire a new fund manager (investment company) to manage your mutual fund’s assets.

So, essentially, you legally own shares in the mutual fund you invest money in, and the investment company is simply a fund manager, who is interchangeable.

The bigger risk than your investment company going out of business, I believe, is it making poor or reckless decisions in managing your mutual fund’s investments. I have yet to hear of an investment company going out of business, but I have read about a lot of investment companies doing a terrible job managing the mutual funds they offer to the public, resulting in these funds exhibiting terrible investment performance for their investors. One of the main reasons I recommend investing in index funds is that they are much less prone to mismanagement than actively managed mutual funds, due to their strict methodology for investing and low level of active trading.

One last observation. You might ask, “Well, if I don’t need to worry about my investment company because they are interchangeable, what about Madoff? If I had invested with him, I would have lost all or most of my savings.” The Madoff investment tragedy, if you are familiar with it, is more a lesson in a complex fraud involving the ability to either collude with and/or fool the independent accounting firm responsible for ensuring that the mutual funds’ investments actually even exist. My takeaway from the Madoff scandal is that it is wise to invest with national or global investment companies, rather than small financial planners, since the scrutiny over these very large companies is greater and the risk for large scale fraud should be diminished.

I hope this information about investment companies is helpful. Best of luck to you in safeguarding and growing your hard-earned savings.

About the Author ()

TIM MCINTYRE retired in 2004 from his position as president of Applied Systems after facilitating a successful sale of the company. At only forty-six years old, he made the unusual decision to fully retire to pursue other interests and simply enjoy free time. As a hard-driving Type A personality, this turned out to be a significant challenge for the Notre Dame and University of Chicago-educated MBA, CPA, and Certified Cash Manager.

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