Why Mutual Funds Go Down as Well as Up

Mutual funds do not always increase in value

A mutual fund's value rises and falls with the performance of the stocks, bonds, or other securities it holds. When those holdings gain value, your fund shares gain value. When they lose value, your shares lose value too. Over long periods, many funds trend upward, but they experience declines along the way — sometimes steep ones — and some funds underperform or lose money over their entire lifetime.

The fund manager's job is to pick holdings they believe will perform well, but managers cannot predict the future. Markets move based on economic conditions, company earnings, interest rates, and investor sentiment. A fund that performed well last year can perform poorly this year. A fund that lost money in 2022 might gain it back in 2023, or it might not.

Key Takeaways

• Mutual fund value depends entirely on what the fund owns, and those holdings can decline in value for months or years at a time.
• A fund's past performance does not predict its future performance, even if the same manager is still running it.
• Some mutual funds consistently underperform their benchmark index, meaning they lose money relative to what a simple index fund would have earned.
• Market downturns affect most funds at the same time, so holding multiple funds does not protect you from broad market declines.

How fund value connects to market performance

A mutual fund's price per share — called the net asset value or NAV — is calculated by dividing the total value of all the fund's holdings by the number of shares outstanding. If a fund holds 100 stocks worth $100 million total and has 10 million shares, each share is worth $10. If those stocks rise to $110 million in value, each share is now worth $11. If they fall to $90 million, each share is worth $9.

The fund manager does not control whether the stocks go up or down. They control which stocks to buy and sell. If the manager picks stocks that underperform the broader market, the fund will lag behind. If the manager picks stocks that decline sharply, the fund will decline sharply. Even a skilled manager cannot prevent losses when the entire market falls, which happens regularly.

Market downturns hit most funds at the same time

When stock markets decline — as they did in 2008, 2020, and 2022 — most stock mutual funds decline too. A fund focused on large U.S. companies, a fund focused on small companies, and a fund focused on international stocks may all fall 20 to 40 percent in a severe downturn. Holding three different funds does not protect you from the downturn itself, because all three own stocks.

Bond funds can decline as well, though usually by smaller amounts. When interest rates rise, the value of existing bonds falls because new bonds now pay higher rates. A bond fund that held bonds paying 2 percent loses value when new bonds pay 4 percent, because investors would rather own the new ones.

The only way to avoid losses during a market decline is to hold cash or very short-term bonds, but that means missing the gains when markets recover. Most long-term investors accept the declines as part of the trade-off for the higher returns stocks and bonds have historically provided over decades.

Past performance does not may provide future results

A mutual fund that ranked in the top 10 percent of its category last year might rank in the bottom 10 percent next year. This happens because markets rotate — technology stocks lead one year, energy stocks lead the next year, and a fund's performance depends on what it owns when each sector is hot. A manager who was right about the market last year can be wrong this year.

Some funds do maintain strong performance over many years, but this is rare. Academic research shows that most funds that outperform their benchmark in one period do not outperform in the next. A few do, but it is difficult to know in advance which ones will be the winners. The fund's prospectus is required to state "past performance does not may provide future results" for this reason — it is a legal requirement because it is true.

Some funds underperform their benchmark consistently

A benchmark is a market index that represents what a fund is trying to beat. A large-cap stock fund might use the S&P 500 as its benchmark. If the S&P 500 gains 10 percent in a year and the fund gains only 8 percent, the fund underperformed by 2 percentage points.

Many actively managed funds underperform their benchmark year after year because of fees. A fund that charges 1 percent per year in management fees needs to beat its benchmark by at least 1 percent just to match it. If the manager's stock picks do not beat the benchmark by more than the fees cost, the fund loses money relative to simply buying an index fund that tracks the benchmark.

Over 15-year periods, studies show that 80 to 90 percent of actively managed stock funds underperform their benchmark index. This is why many investors choose index funds or exchange-traded funds (ETFs) that track an index instead — they charge lower fees and match the market's performance rather than trying to beat it and falling short.

How to think about fund declines

A fund decline is not a permanent loss unless you sell during the decline. If you own a fund worth $10,000 and it falls to $8,000, you have lost $2,000 on paper. If you hold the fund and it rises back to $11,000, you have gained $1,000 overall. If you sell at $8,000, you lock in the $2,000 loss.

This is why investment advisors often recommend holding funds for at least five to ten years. Short-term market movements are unpredictable, but over longer periods, diversified portfolios of stocks and bonds have historically recovered from declines and reached new highs. The longer your time horizon, the more you can tolerate declines along the way.

If you need the money in the next two or three years, a mutual fund that holds stocks is a risky place to keep it, because you might be forced to sell during a decline. For money you will need soon, cash or short-term bond funds are more appropriate, even though they earn less.

Frequently Asked Questions

Can a mutual fund lose all its value?

A diversified mutual fund holding many different securities is extremely unlikely to lose all its value, because that would require nearly every holding to go to zero. A fund holding a single stock or a narrow group of stocks could theoretically lose most or all of its value if those companies fail. Most mutual funds are diversified enough that a total loss is not a realistic risk.

What is the difference between a fund going down and a fund performing poorly?

A fund going down means its value declined — the NAV fell. A fund performing poorly means it underperformed its benchmark or its category peers. A fund can go down (lose value) and still perform well if its benchmark also went down by more. A fund can go up (gain value) and still perform poorly if its benchmark went up by more.

If I own a fund that lost money last year, should I sell it?

Not necessarily. A one-year loss does not mean the fund is bad or will continue to lose money. If you chose the fund based on its long-term strategy and your own time horizon, a single down year is normal. Selling after a loss locks in that loss and often means buying back in after prices have risen, which is the opposite of the buy-low, sell-high principle. Review the fund's strategy and fees, but do not make decisions based on short-term performance alone.

Why do some mutual funds gain value while others lose it in the same year?

Different funds hold different things. A technology stock fund might lose 30 percent in a year when tech stocks fall, while a utility stock fund might gain 5 percent because utility stocks held up better. A bond fund might gain 2 percent while a stock fund loses 10 percent. The fund's holdings determine its performance, not the overall market alone.