Mutual funds can be a great investment option for those who do not want to research the stock market on an individual company basis. Mutual funds bundle together a bunch of stocks, so that your risk is minimized. You should also understand that by doing so, your profits are usually limited as well, since you do not make as much as the best performing stocks but only the average of a group of stocks.
Mutual funds work best when you want to diversify and thus minimize your risk in the stock market. They are thus good for long term investments. They work well in the short term too, but not too short term (like day trading) because of the commissions involved. They can give great returns when you keep your money in the fund for at least a few years.
Finding the right fund isn't an easy task. There are hundreds of practical options available to investors. Just so you have an idea of their diversity, there are now the so called 'fund of funds', which are essentially a bundle together of several mutual funds! So it does help to know what kind of mutual fund suit your investment portfolio.
First, you need to determine what kind of an investor you are. If you like to hold your investments for a very long time, there are several kinds of mutual funds you might like. For example, technology companies, energy companies, etc. are good to hold for a long term because they are the drivers of the economy and usually are going to increase in value given a sufficiently long time.
On the other hand, some people invest with a fixed time period in mind, like a year or two. They might want the money back for a specific task, like their marriage or sending their kids to college. In such cases, you will need to look at the market from a short term perspective. For example, funds that invest in developing nations give good short term yields because of their tremendous growth.
Just like with stocks, you can diversify your mutual funds. Thus you might want to invest in a mutual fund specializing in green energy companies and another mutual fund investing in blue chip stocks. This will usually reduce your risk.
Even though, by their very nature, they minimize risk, they do not take into consideration the event when a whole sector falls. During the financial meltdown of 2008, there were many mutual funds investing in the banking sector that were annihilated by the downturn. This is because the whole banking sector had collapsed and all banking stocks fell in value. The most notable names in the industry were beaten to the ground. Thus diversifying in different areas with mutual funds will avoid such huge losses. Also, if your fund gives you losses, it might be a good idea to stay invested in the long term till the market regains in value. This is because over a long term, the fund should grow with the industry it is tracking, and unless in a recession, most industries do grow over time.
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