Why Mutual Funds Represent the Ultimate Investment Risk

What Wall Street fears the most is a run on the mutual funds, because when that happens, the Fed won’t be able to stop it, and the stock market will collapse.

So, to protect themselves from a run on these funds, companies ask you to sign a Mutual Fund Risk Disclosure Statement when you purchase into such funds. There are two points in that disclosure statement that are very important. First, it states “Under the Investment Company Act of 1940, these funds may ‘redeem shares in kind’ (rule 18F-1). This means that under certain conditions a fund may redeem shares or assets in other than cash, such as debt equities held in the portfolio.” Second, they say, “Under certain crisis market conditions, the Security Exchange Commission (SEC) may allow these funds to suspend redemptions.”

What does all that mean? It means that if there is a run on these fund investments, and if they just ran out of cash, they can pay you in ‘kind’ – that is, any other ‘kind’ of paper. And regardless of whatever kind of paper they give you, whether it is stocks, securities, bonds, or a combination of all of the above, if you want to make a dollar on it, you have to find a buyer on the street. That is the truth about mutual funds.