Is it possible to lose all of your investment in an index fund?

There are few certainties in the financial world, but we can say that there is almost zero chance that any index fund could ever lose all of its value.

There are a few reasons for this. First of all, virtually all index funds operate with a very high level of diversification. Most index funds attempt to mirror some large basket or index of stocks, such as the S&P 500, by simply buying and holding identical weights of each stock as the index itself. Thus, because an index fund's holdings are almost always extremely well diversified, making it is virtually impossible that all of these holdings' market prices would fall to zero, destroying the value of the entire index. (For further reading, see Introduction To Diversification and The Importance Of Diversification.)

Think about it this way: If you randomly pick 100 companies, the odds that a single company of the 100 will go bankrupt might be quite high. However, the odds that each and every one of the 100 companies will go bankrupt and leave shareholders with zero equity is essentially nil. Thus, an investment in a typical index fund has an extremely low chance of resulting in anything close to a 100% loss.

Furthermore, the overall stock market, which most index funds tend to represent with their holdings (or at least a portion or particular sector of the overall market), is almost certain to be producing tangible value over the long-term. Because of this, the total book value of all the underlying stocks in an index is expected to go up over the long term. This ensures that any well-diversified index fund will not significantly decline in value over the long term.

To learn more, check out Index Investing and Being Lazy With A Couch Potato Portfolio.

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