Advantage of a diversified portfolio is if a portfolio is spread across 20 stocks, if any one of those stocks quickly loses value the effect is less than if the portfolio consisted of that one stock by itself.
When investing it is always a good idea to diversify. The problem for small investors is that they often don't have the funds to buy a variety of stocks. Mutual funds allow small investors to benefit from diversification with a small amount of money.
Besides stocks, mutual funds can be made up of a variety of holdings including bonds and money market instruments. A mutual fund is actually a company and investors that buy into a fund are buying shares of that company. Shares in a mutual fund are bought directly from the fund itself or brokers acting on behalf of the fund. Shares can be redeemed by selling them back to the fund.
There are downsides to mutual funds. There are usually fees that must be paid no matter how the fund performs, and the individual investor has no say in which securities can be included in the fund. Also, the actual value of a mutual fund share is not known with the same precision as stocks on the stock market.
Of course, mutual funds can also lose value, especially in the short term, so short term investors may be better off with bonds which offer a set rate of return.
Mutual funds are an ideal investment for those with limited funds or investment experience. Choosing the right fund is a decision on how much risk you are willing to take against your expected return on your investment.
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