What Happens If A Company My Mutual Fund Owns Shares Of Goes Bankrupt?Jul 1, 2013
By Staff writer State Farm™ Employee
A reality of business is that not everyone will succeed. Every year, some companies will go bankrupt, either due to mismanagement or to a general decline in economic conditions.
Because decline can happen so rapidly, especially if fraud is involved, the analysts and portfolio managers who work on a mutual fund won’t be able to avoid them all. If a company does go bankrupt, any mutual funds that own its shares will have to take a loss, and that may affect performance.
You have some protection, though, because mutual funds have diversified portfolios of securities. Under the Investment Company Act of 1940 that governs mutual funds, a fund cannot have more than 25 percent of its holdings in any one security. The other 75 percent must be divided among at least 15 different securities so that none of them represents more than 5 percent of the total fund. Furthermore, none of those 15 securities can own more than 10 percent of the stock of any one company. That policy limits the effect on the fund if any company were to go bankrupt.
In practice, most mutual funds own more than 16 securities in total, and very few allow any investment to be more than 10 percent of its total position. This is done to try to make the effect of a total loss on one investment fairly small relative to the entire fund.
Money market1 funds have more stringent rules than stock and bond funds. They may not invest more than 5 percent of funds in any one company, and they may only purchase short-term securities.
The economy will be poor sometimes, and some companies will fail. That may affect a fund that you invested in. However, one of the benefits of diversification is that your mutual fund will hold other investments that won’t be affected by the bankruptcy. An investor who buys shares in just one company may not be as fortunate.
Of course, diversification does not assure a profit or protect against loss in a declining market. However, by investing in a diverse portfolio, fund managers attempt to minimize the effects of any downturn in any particular company, country, and/or sector.
1An investment in the Money Market Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.Securities Issued by State Farm VP Management Corp. For more information, call 1-800-447-4930.
Securities are not FDIC insured, are not bank guaranteed and are subject to investment risk, including possible loss of principal.
Bonds are subject to interest rate risk and may decline in value due to an increase in interest rates.
Neither State Farm nor its agents provide investment, tax, or legal advice.