- It's important to distinguish between the bankruptcy of a company a mutual fund owns stock in, and the mutual fund itself. Mutual fund bankruptcy is extremely rare due to the fact the industry is heavily regulated. If a company a fund is invested in goes bankrupt, the fund takes a loss. However, funds are generally well-diversified, so the loss taken from the failure of one investment is unlikely to have a big impact on the price of the fund itself.
- Mutual funds are not protected from bankruptcy, but shareholders in the fund are. The Investment Company Act of 1940 sets provisions that bar a mutual fund company from raiding customer assets in the event they go bankrupt. In other words, the stocks owned by the fund, at the time the fund goes bankrupt, belong to you -- and the fund cannot sell them in order to meet its own financial obligations.
- While a fund cannot sell your account to pay its own creditors, a fund manager can potentially mismanage the fund, causing large investor losses. In other words, the fund manager can make bad investment decisions and take losses in the market. Likewise, poor market conditions can cause your fund unit prices to decline. Mutual funds tend to be less risky than individual stocks, but they're not risk-free.
- Owning a mutual fund that's part of a large fund family is one way to reduce risk. It's less likely that a large fund family will go bankrupt. In addition, fund families tend to cherish their reputations, for if their name is soiled, it can have a big impact on sales. Thus, fund families will sometimes cover major losses if a fund manager mismanages accounts.
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