Can Mutual Fund Investment Drop to Zero?
A thought that can give any investor a nightmare – what if I wake up and my investment reduces to zero! What will I do? What if it becomes negative? As an investor, I understand this concern.
While I know that the possibility of either of this happening is infinitesimally small, the thought itself is stressful. Also, considering the term unprecedented being associated with markets off late, who knows, right?
To answer this question comprehensively, let’s break it down into smaller parts:
Can My Investment Reduce to Zero or Go Negative?
Theoretically, any investment can reduce to zero. So, if you have invested in stocks and one company goes bust, then the value of your investment in those stocks becomes zero. That is the risk of investing in equities.
On the other hand, if you have invested in mutual funds, then I don’t see this happening unless the world literally falls apart! However, while the return on your investment (ROI) can be negative, there is no way your investment itself becomes negative – meaning you owe money to someone – that is NOT POSSIBLE. For the sake of this article, I will focus on mutual funds and keep the discussion about stocks for later.
Having said this, in the history of mutual funds, there has never been a time when the value of a fund portfolio has dropped to zero (at least not that I know of). I mean think about it; the value of a mutual fund portfolio will fall to zero when the value of all the securities and assets it has invested in drops to zero.
Example
Let’s take an example of the high-risk small-cap equity fund that invests 80% in small-cap stocks and 20% in AA-rated bonds. For the value of this fund to become zero, the prices of all stocks need to become zero implying that all the small-cap companies need to shut and the values of bond investments need to become zero (theoretically impossible unless the country’s economy crashes).
Therefore, while the answer to the question was affirmative, the chances of it happening are negligible. Feeling a bit better? I hope so!
Let me answer another question that is scarier than our first question because it is more probable:
What If My Investment Reduces to 25% Of Its Value?
Scarier because given a market crash and an investment portfolio that lacks diversification, for some investors this might be a reality today! So, let’s assume this scenario and look at the best ways to tackle it:
#1. Don’t Sell In Panic
Imagine investing Rs.5 lakh in mutual funds and finding it at Rs.1.25 lakh today! It is bound to create panic. However, before you go on a selling spree, I want you to think about a couple of things:
- Notional Loss and Book Loss – Currently, since you have not sold your investments, you have a notional loss or a loss on paper. This means that when the markets recover, these losses can reduce and you can also book profits. (Note that I used the phrase ‘when the markets recover’ and not ‘if the markets recover’). On the other hand, if you sell right now, then you will book the loss and no matter what happens in the markets, you will be unable to recover these losses.
- Opportunity Loss – Let’s say that you had invested in these funds in 2018 and held on to them through the ups and downs of the market keeping a long-term view. If you sell now, you would also have lost the opportunity to gain profits by staying invested in the longer term.
Remember, historically, markets have always recovered from crises and disasters and selling when they are down can be counterproductive.
#2. Analyze Your Investments
Before you do anything, sit down with all your investments and study them. Look at the fundamentals of the securities or assets that you have invested in. For example, if you have invested in a mid-cap equity fund, then look at the portfolio holdings of the fund and assess if it will be able to weather the current market storm or not.
Avail the services of an investment manager to help you determine the investments that are worth holding on to and the ones that you can sell when the opportunity presents itself.
#3. Always Remember Your Investment Goals
Regardless of what the current situation feels like, remember why you invested in the fund, to begin with. Typically, equity mutual funds are preferred by long-term investors with financial goals more than 5-10 years away. If that’s you, then stick with your plan if the fundamentals of your investments are strong (refer #2 above).
#4. Markets Will Always Be Volatile
The pandemic has not just affected the markets but dampened our spirits as well. Most of us are combating the feeling of doom and gloom. In these times of uncertainty, it is easy to assume the worst and panic.
However, you must remember that markets are-have been-and always will be volatile. While this might not be something that you have seen before, as soon as the world gets a grip on the pandemic, the markets are bound to bounce back.
#5. Diversify Your Portfolio To Reduce Risks
Yes, you read that right. If your portfolio is adversely affected due to the lack of diversification, then you must start looking at investment avenues that can help you diversify while benefiting from the low prices right now.
Look for investments that have no correlation with your portfolio. This means that if the value of your portfolio rises/drops, the value of these new investments should not be affected.
By doing so, you will reduce the overall risks of your portfolio and stand a better chance to recover your losses once the markets start getting optimistic.
Summing Up
Remember, while these may be unprecedented times, humans have bounced back from the worst disasters one can imagine and moved ahead. When this crisis will be over, investors who stayed invested and strategically and slowly invested more would have the best opportunity to make good profits.
Sit down with your investments and think well before making a decision.
Happy Investing!