Will mutual fund investment drop to zero ever? This question is the worst nightmare for any investor. Be it a newbie or a veteran. Be it any investment, the possibility of it losing value is quite normal. Theoretically, investments can drop to zero. However, the probability of it is quite low.
If you’ve invested in stocks and one of them goes bankrupt, your investment in those stocks is worthless. That is the danger of investing in stocks.
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On the other hand, mutual fund investments losing their value means that the world is falling apart. For a mutual fund to lose its value and become zero means that all the holdings in the portfolio must become zero or worthless. The probability of all the assets becoming zero is extremely low.
It is quite possible that your investments are giving negative returns. But it is highly unlikely for the value of a fund portfolio to become zero. While the return on your investment (ROI) can be negative, it is impossible for your investment to become zero. In other words, you owe money to someone.
Let’s take an example to understand the scenario better. Consider the high-risk equity fund that invests in small-cap companies. It holds 80% of its assets in small-cap stocks and 20% in AA-rated bonds. All stock prices must fall to zero for this fund to become worthless. All small-cap companies must go bankrupt, and the bond investment values must fall to zero. Such a scenario is highly unlikely unless the country’s economy collapses.
Since it’s clear that the fund’s value may not become zero that easily, the bigger worry is actually when the investment value drops. Let’s understand what to do when your investment value drops during your investment tenure.
What Happens If My Investment Value Drops?
This scenario is even scarier. Given a market crash and an undiversified investment portfolio, this may be a reality today for some investors! When your investments lose value, you need to analyse your holdings carefully and take a strategic call rather than making decisions in haste.
The following tips will help to overcome the anxiety and make a more informed decision regarding your investments:
1. Never Sell in Panic
Let’s say you have invested INR 1,00,000 in mutual funds, and it is now worth INR 25,000. Such scenarios will certainly cause panic among investors. The main question would be should you sell your holdings and stop any further loss. Or hold on to them and wait for market corrections. However, before you go on a selling binge, it is wise to consider the following:
- Notional Loss and Book Loss: You currently have a notional loss or a loss on paper because you are still holding your investments and have not liquidated them yet. This means that if markets rebound, your losses will be reduced, and you will be able to book profits. Also, if you choose to sell right now, you will book a loss. And, you will be unable to recover your losses no matter how the markets may be in the future.
- Loss of Opportunity: Assume you bought these funds in 2020 and held them through the market’s ups and downs, preserving a long-term perspective. If you sell now (when the markets are falling), you’ll miss out on the possibility of benefiting in the long run by staying invested.
Remember that markets have always rebounded from crises and turmoil in the past. Therefore, selling while they’re down is not ideal if you are a long-term investor.
2. Keep In Mind Your Investment Objectives
While investing in a mutual fund, we often align our investment objectives with the fund’s objective. Markets are volatile, and thus fluctuations in your investments are quite common. It is quite possible that your fund may underperform during a certain period. Therefore, even when the markets are volatile or if your fund is giving negative returns, you should keep in mind your investment objective before exiting the scheme.
If you have a long-term investment horizon, you should stay invested in the fund and not worry about these short-term fluctuations. Furthermore, a long-term investment perspective will help you generate significant returns as it averages out the effect of market volatility. Therefore, you should not worry about short-term market volatility.
3. Assess Your Investments
Even before thinking about liquidating your investments, you should first analyse your holdings. Study the fundamentals of the securities and assets you hold. Say, if you have invested in a small cap fund, analyse the fund’s portfolio holdings to see if it can withstand the current market turmoil. It is also essential to analyse if the fund’s holdings have the capacity to bounce back if the markets start to recover.
Analysing your investment portfolio and making decisions requires skill, knowledge and time. If you do not have the knowledge and time to do it yourself, take the help of a financial advisor. Depending on your investment objective, tenure and risk levels, the advisor will analyse the funds and suggest an appropriate strategy.
4. Diversify Your Assets to Lower Your Risk
If your portfolio is suffering from a lack of diversification, you should begin looking for investment opportunities. Diversify while taking advantage of the current low pricing. Look for investments that are unrelated to your current portfolio. In other words, the new investments must help you average out the effect of market volatility on your investment portfolio.
Therefore, through diversification, you can lower your portfolio’s total risk. And also have a higher chance of recovering your losses once the markets begin to recover.
5. Markets Will Always Be Turbulent
Markets are always volatile. Most investors have engaged in panic selling during the 2008 crash or the most recent crash (during the pandemic). If you are certain that you have invested in fundamentally strong investments, you do not have to worry about these market falls.
Markets always correct themselves, and no trend is permanent. Hold on to your investments through a market crash, and you may generate significant returns once the market recovers. Having said this, it is important that you strategically invest during a market crash. A market crash gives you an opportunity to accumulate a greater number of units of the fund. And, you can enjoy higher returns once the markets recover. Therefore, do not sell your investments only because the markets are falling. Make sure you analyse the investment portfolio and make an informed decision.
The possibility of your mutual fund investment dropping to zero is an extremely unlikely situation. This is because mutual funds invest across different assets and not just one. So, even if you lose money on one or two financial instruments, you can still profit from the other securities.
When deciding to invest in mutual funds, you must have a long-term investment horizon to generate significant returns. A mutual fund’s Net Asset Value (NAV) may fall sometimes, but there is nothing to be concerned about. The only way mutual fund investment drops to zero is if all of the financial assets that it is made up of lose value. Such a scenario is exceedingly unlikely because not all financial instruments lose value at the same time.
Market fluctuations are normal, and when the crisis is over, investors who stayed invested and strategically and gradually increased their investments will have the best chance to generate significant returns.
Mutual fund investments are volatile. Before deciding, analyze your portfolio based on your goals, tenure and risk profile. After a thorough analysis, take a call on whether to sell or hold on to your investments.