Diversification in mutual funds and ETFs
I'm trying to undertand deversification in mutual funds, specially in contrast with having your own stocks.
Mutual funds and ETFs that track some index (S&P, DJIA...) are diversified by definition.
Still, if you invest in one of the above, you don't own the actual stocks, so you are actually investing all your money in just one asset (index fund/ ETF). If something happens to the mutual fund and it crashes, you lose everything.
Is the above correct?
Does it make sense to invest in different index funds that track the same index, as a security measure?
(3)3 Comments
Sorted by latest first Latest Oldest Best
If something happens to the mutual fund and it crashes, you lose everything.
Theoretically, yes, but the point of diversification is that the odds of ALL of the underlying stocks going to zero is infinitesimal. Certainly there can be large economy-wide crashes, which is why you can further diversify into multiple mutual funds covering different markets (real estate, bonds, international, etc.) to further reduce risk.
If you pick one apple off the tree, what are the odds that it's rotten? Now buy a basket of 100 apples. What are the odds that ALL of them are rotten? THat's the point of diversification. One company con go bankrupt, but the odds of the top 500 public companies in the US going bankrupt is virtually zero.
Does it make sense to invest in different index funds that track the same index, as a security measure?
No - that would be pointless. They should have roughly the same risk and return unless there's significant tracking error, which is possible, but the diversification benefit should be very small in that case.
If something happens to the mutual fund and it crashes, you lose everything.
Nothing will happen to the mutual fund that doesn't also happen to the underlying index.
What might happen is that the brokerage goes bankrupt or collapses due to some malfeasance.
The SIPC should pick up the pieces after you, but that will take time. Better to just invest with large, time-tested brokerages without a history of shenanigans.
Read JL Collins stock series. Part 10 provides a good explanation of why a large regulated brokerage that tracks an index can't crash.
"1. You are not investing in Vanguard, you are investing in one or more of the mutual funds it manages.
The Vanguard mutual funds are held as separate entities. Their assets are separate from Vanguard, they each carry their own fraud insurance bonds, each has its own board of directors charged with keeping an eye on things. In a very real sense, each is a separate company operated independently but under the umbrella of Vanguard.
No one at Vanguard has access to your money and therefore no one at Vanguard can make off with it.
Vanguard is regulated by the SEC."
"But, if you are expecting a planet or even just a civilization ending event, Vanguard’s not for you. But then, no investments really are. You’re already stocking your underground shelter with canned goods. Short of that, you can sleep just fine with your assets at Vanguard. I do."
Terms of Use Privacy policy Contact About Cancellation policy © freshhoot.com2025 All Rights reserved.