But should every investor spread assets among multiple financial firms or is the decision made on a case-by-case basis? What are some good reasons for investing in more than one mutual fund company?
When a Mutual Fund Company Goes Under
When you hold mutual funds, they are typically held in trust on behalf of the investor and are not assets of the mutual fund company or brokerage firm itself. For this reason, investors should note that it is extremely unlikely that a mutual fund company or brokerage firm will fail and thus cause investors to lose money. If an extreme and rare event occurred, such as bankruptcy, when the funds and the fund company are separate legal entities, the fund company’s creditors could not claim the funds’ assets to pay the fund company’s debt obligations under the bankruptcy. In this worst-case scenario, the investment company that manages the mutual funds could get into financial trouble, but not the mutual funds themselves. In an extreme and negative financial event, each fund’s assets would remain in the protective custody of the fund’s custodian bank. As a result, the investors would still be able to redeem or transfer mutual fund shares to another company. The mutual fund company may also be forced to sell their business to another mutual fund company or investment management firm. In any case, this would not lead to a total loss for you as the investor.
When Mutual Fund Losses Are Covered
In the unusual case where some or all of a customer’s cash and securities are missing, Securities Investor Protection Corporation (SIPC) insurance covers losses up to $500,000 (maximum of $250,000 for cash losses) for mutual funds covered at an SIPC-member brokerage firm. Therefore, if an investor wanted to play it as safe as possible, they would not hold more than $500,000 in mutual funds at one company. Keep in mind, though, that SIPC protects investors from the bankruptcy or insolvency of a brokerage firm. Mutual fund companies are not brokerage firms, so their clients do not receive SIPC protection. The only real protection mutual fund investors get is if they have cash in a sweep account or deposit account that is proprietary of the brokerage company.
The Diversification That Matters
It is important to note that bankruptcy of a mutual fund company, especially a large one like Vanguard or Fidelity, is not likely to cause extreme financial problems that would harm investors. The only real risk that mutual fund investors should be concerned about is market risk (the loss of principal). Of course, that same risk is part of the potential for achieving high returns. To achieve proper diversification, investors should focus more on diversifying among several mutual fund types, not mutual fund companies. This mutual fund mix should include riskier equity funds, conservative fixed-income funds, and short-term focused money market funds. Creating a blend of fund types is your best protection against swings in the market, which poses a far greater risk to you than any specific mutual fund company. If you have more than $500,000 to invest, then splitting your funds among a few mutual fund companies may be wise in order to ensure they are protected by the SIPC. Otherwise, it’s not really a necessity.
