What are Protected Funds?

A protected fund is a mutual fund that guarantees its shareholders will realize at least their initial investments—even if the stock market drops. Protected funds usually require investors to hold their shares in the fund for a specified period of time. For most funds, this ranges between five and ten years. Investors who sell their shares prior to the end of this period lose their guarantees on the shares. If the share prices drop prior to a sale, an investor may also realize those additional losses.

Once the guarantee period is over, most protected funds liquidate their assets. Some funds will continue to operate, but will no longer offer any guarantees to their shareholders. These types of funds often reinvent their investment strategies, with many of them moving into equities.

Many protected funds take out an insurance policy to back the guarantees offered to investors. While investing in an insurance-backed fund offers added protection, it is not without risk. Investors should review the credit rating of the company backing the guarantee. Although it is rare for these types of companies to fail, it is possible. Researching a company’s financial strength prior to investing can help mitigate this risk.

While most protected funds invest in a mixture of securities, they generally place the bulk of their investments in safe ventures. Common investments include fixed-income securities, zero-coupon bonds, and high-grade bonds. When markets are volatile, a protected fund is more likely to invest in securities and bonds because these types of investments present less risk. For investors, this may mean a lower rate of return on their investments. It can also mean losing potential gains if stock prices surge.

Protected funds can offer investors a way to invest in the stock market while having the security of retaining their initial investments. While this may initially sound like a solid investment, investors should be aware of potential downsides prior to handing over their hard-earned money. In general, protected funds charge higher expense ratios than non-protected funds. Investors can also be subject to other fees, such as sales charges or penalty fees for withdrawing funds early.

Investors who may need ready access to their funds should be cautious when considering investing in a protected fund. Depending on how the fund is structured, early withdrawal may mean losing the principal guarantee and facing early withdrawal fees. Some funds may also penalize investors who elect to receive cash dividends rather than reinvesting those dividends in the fund. In addition, a protected fund can have tax implications for some investors. In some countries, investors may be required to pay income tax on returns, even if they do not receive cash distributions.