Mutual funds work by combining the money of many investors into a single, professionally managed investment. The resulting pool of money can be invested in a wide variety of investments, including stocks, bonds or even other mutual funds.
When an investor purchases a share of a mutual fund, she immediately gains a measure of diversification in her investment holdings. This is true because instead of purchasing a single stock, for instance, she is buying a portion of a fund that may own hundreds of different stocks. When one stock in the portfolio performs poorly, other well-performing stocks can offset that disadvantage. Since mutual funds can own many types of asset classes, a single investment has the potential to provide all the diversification that an investor needs. While building a diversified portfolio of individual stocks and bonds requires a large outlay of capital, mutual funds are accessible to just about everyone, because they can be purchased with small dollar amounts. Most people have a need to invest, but they may not have the expertise to invest wisely. A mutual fund often places investment decisions in the hands of a professional money manager. With the goal of increasing value and managing risk, the fund manager decides what investments to buy and sell.