- The Washington Times - Monday, October 20, 2008

Incurrent market conditions, fund investors are questioning just about everything. Here are some of the most common questions from readers over the past few weeks.

Q: Can my stock mutual fund go to zero? Could I lose everything if I don’t sell?

A: Mutual fund share prices are based on the value of their underlying holdings. So if a fund held all of its assets in one stock, and that stock went belly up, then the fund’s shares would be worthless.

But to qualify as a “diversified” fund under securities law, a fund must have at least 16 positions, and most have far more than that. All of those stocks would have to become worthless for the fund to go to zero.

That said, the chances of a fund becoming worthless are slim. But the potential for a fund to suffer devastating losses … well, you need only open your most recent statement to see that things can get pretty ugly long before a fund approaches zero.

Q: My fund company is a member of the Securities Investor Protection Corp. Does that mean my mutual funds are covered?

A: Definitely not. The government has recently gotten into creating an insurance fund for money-market mutual funds, but that’s not SIPC. Moreover, there’s no government protection against investment losses.

SIPC protects consumers against default by their broker. Some investment firms that operate funds have SIPC protection, but it covers their brokerage operations and not their funds. If your fund shares are in a brokerage account, you’re covered if a brokerage collapse directly affects your account, which is highly unlikely; your money is with the fund, which is a separate investment company, and your share price is based on the fund’s holdings, not the brokerage’s troubles.

In addition, fund assets are held by a custodian, so that if the fund management company busts, creditors can’t go after the fund’s assets.

Q: If almost every fund company is buying insurance for their money-market funds, are they predicting another big collapse? Should I get my money out now?

A: On Sept. 19, in the middle of the biggest-ever run on money-market funds, the Treasury created an insurance program intended to calm people down. The plan is voluntary, and fund firms had until Oct. 8 to decide if they would participate; virtually all fund firms did, although some opted not to insure their government or Treasury funds.

The idea here is to get protection against “breaking the buck,” which is what happens if the securities held by a money fund suddenly drop in value, leaving the value of the fund’s holdings below $1 per share, which is supposed to be the constant price. The prospect of a fund breaking the buck is enough to cause a run on assets, which can turn a prospective loss into a reality; that’s precisely what happened to the funds that broke the buck in mid-September.

Talking with executives from many of the participating fund firms, they’re not signing up because they expect rampant defaults in money-market paper. Instead, they’re doing it because they know it will calm down investors, because they don’t want a lack of coverage used against them by the competition, and because they’re not above raising expenses to cover the cost, so it’s not the management company’s bottom line that is going to suffer. And, of course, while the fixed-income specialists are saying they don’t expect to see problems bad enough that more funds break the buck, the market and the global economy have surprised a lot of folks lately, so why not take the insurance, just in case.

The insurance program is set to expire in three months, but could be extended for up to a year. Expect it to go 12 months, but don’t expect it to actually come into play often during that time. And if you remain nervous about money funds, consider bank deposits as an alternative, since it’s not like you will be sacrificing yield if you make the change.

Q: Can you give me a reason to hang on to my funds?

Hopefully, you can give yourself reasons; when you buy a fund, the first thing you should do is write down all factors that went into your decision, including your expectations. That way, you can judge a fund based on how it has met your personal criteria.

For someone looking to hang on - meaning they are trying to convince themselves to look past current losses - a fund scores points if it has done the job you picked it for. Even in bad times, for example, the top performers in an asset class get high grades from research firms for beating the average in the category.

If you never made a list of your criteria for buying, think back to when you were buying and decide if the fund has met your expectations in every way except for recent performance; for a buy-and-hold investor, your fund is not going to zero and that’s not everyone - buying and selling decisions should be about more than recent performance.

c Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.


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