• Volatility inherent in individual stocks can be mitigated via funds' diverse portfolios.chart background image by Stasys Eidiejus from Fotolia.com
  
  Investment in common stock has traditionally provided higher returns than most other financial instruments. However, along with this performance also comes risk. Stocks are one of the most volatile investments and to balance performance with risk, mutual funds were developed. These composite instruments have proven popular and are now used quite widely.
  
  

Diversification

• Volatility is a term referring to the fluctuation in price of an asset. The volatility of stocks is quite high in comparison with other instruments in this presents the investor with considerable risk. Investing professionals mitigate this risk with a technique called diversification. It is assumed that some the market forces that drive an individual security up or down will not have an equal effect on all such securities. Because of this, an investor can be protected from depreciation of the security by holding other securities, which presumably will not be negatively affected to the same degree. Diversification means not only holding different stocks, but stocks from different industries, stocks from different sectors of the economy as well as instruments of those in stocks, including bonds, certificates of deposit or even some holdings in cash or money market accounts.
  
  

Fund Structure

• Mutual funds represent a way for an investor to diversify his holdings "instantly." The mutual fund is a portfolio which is managed by professional investors and consists of a variety of holdings. Private investors purchase shares of the fund as if they were buying a stock or other security. The fund manager controls the specific balance of securities contained within the fund. The fund itself is owned by the investors in a manner similar to how publicly traded companies are owned by shareholders.
  
  

Fund Types

• A variety of mutual funds cater to the various needs of investors. Some funds are quite aggressive in attempting to produce a high yield, while others are more conservative and prioritize preservation of investment capital. Instruments held by funds also vary. Funds can be dedicated to holding bonds or other instruments as well as stock. Some funds specialize in one type of instrument while others hold multiple types of instruments. As to be expected, common stock funds are composed predominantly, or exclusively, of stock issued by publicly traded companies.
  
  

Advantages/Risks

• Mutual funds, stock funds and others, have been hailed for various advantages. Because very large sums of capital are aggregated in the fund's and managed by professional fund managers, the investors in these funds benefit from economies of scale. The commissions paid on transactions are distributed to all the holders of the fund, thus the individual investor's burden in commission or other transaction costs is considerably lower than would be the case if using a personal broker. Considerable time and effort can also be saved by simply selecting a fund representing the desired degree of risk balanced with the expected return. Funds are not without their critics. Shares in funds are sold by individuals working on commission and these representatives may be operating more from self-interest than an attempt to provide the best product. Not all funds perform at a level that justifies fees, commissions or other costs.