Most people have neither the time nor interest to research and select individual stocks and bonds for their investment portfolios, and that's where mutual funds come in. Mutual funds are composed of stocks, bonds and other assets, giving you diversification, which means a decline in value in any one stock or bond won't significantly hurt your overall return. A handful of well-chosen mutual funds or index funds can offer a diversified portfolio that allows the individual investor to spend his or her time on other pursuits. Thousands of mutual funds are available that can satisfy the objectives of different types of investors.
Investors are often advised that they shouldn't "put all their eggs in one basket." Investors who have too high of a percentage of their assets in one or two stocks can be severely affected if one of the companies goes belly-up. Most financial experts say investors should have at least 15 stocks in their portfolios. It takes a lot of time and effort to keep up with that many companies. Conversely, mutual funds hold a number of stocks, which gives investors instant diversification and protects them from a sharp decline in any one holding.
Some mutual fund investors are looking for rapid growth in the value of their funds. Stocks have historically offered the best long-term returns of any asset class, though it can be an up-and-down ride. Stock funds that are labeled "growth" typically invest in companies with bright prospects, while "value" funds target stocks that seem inexpensive compared with the company's earnings.
Other fund investors care more about receiving income from their investments. Numerous stock funds invest in companies with high dividend payouts. Bond funds also can provide steady income, as can funds that invest in real estate investment trusts, or REITs. All these income-focused funds pass the yields along to their investors, usually on a monthly or quarterly basis. Yields of 3 percent to 7 percent are often available with income-oriented mutual funds.
Some large international firms offer their shares on U.S. markets, but others don't. For example, individual investors can have a hard time getting access to shares in the fast-growing Chinese market. But international-focused mutual funds have an easier time investing in these shares. Because half the world's corporate value is outside the U.S., it's important to have some exposure to overseas stocks, and mutual funds are the easiest way to get this.
Stock picking can be expensive thanks to broker commissions, but many "no-load" mutual funds are available that don't charge investors anything. Many other funds charge investors less than 1 percent a year for operational fees.
Investors looking for especially inexpensive funds might consider index funds, which charge fees as low as 0.1 percent per year. These funds usually hold every stock or bond in a given asset class, which offers tremendous diversification at a low cost.