If a mutual fund company fails?

Question: If you own mutual funds through a company such as Vanguard or Fidelity, what happens if the company goes bankrupt. Do you still own the underlying equities or is your investment lost? If it varies by fund or institution, how do you distinguish between them? Stephen, Berkeley CA

Answer: What a long way we've come over the past year, and not for the better. Questions like this used to be highly abstract, but now we need to take them seriously.

In essence, mutual fund investors don't have to worry. Your investment isn't lost.

The money you've invested in the mutual fund is safe even if the fund company goes belly-up (like Lehman) or needs a federal bailout (like AIG). There are several lines of safety. For one thing, you're a shareholder in a mutual fund. Your money isn't an asset of the fund company itself. For another, you and all the other shareholders in the fund actually own the securities, not the mutual fund company.

What's more, the securities--stocks, bond, and the like--are held in a segregated custodial account, which is typically managed by a bank or trust. Mutual fund companies carry mandatory insurance. If it has a brokerage business, any accounts there will be covered by the SIPC. Another financial institution would likely swoop in and manage the mutual funds, too.

Of course, these layers of protection that ensure the money is yours do not affect the value of that money. And for most of us that means portfolios are off anywhere from 20% to 40%.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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It is sad that these kinds of question are surfacing. The problem (of fund defaults) may come from the numerous layers of management that publicly traded mutual fund families face along with performance expectations by the shareholders of those companies.

Funds fail because of a lack of value perception. Fees don't seem nearly as high when the fund is performing at its peak. But once those returns are jeopardized, even if, as in the current market it was not your fund manager's fault, those fees look some much more ominous. And couple that sudden realization with a long market downturn and redemptions skyrocket. After that, the weak (and too expensive) funds fall like dominoes.

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