Mutual funds reduce risk by instantly diversifying. Instead of buying a single stock or bond, your mutual fund investment buys dozens or hundreds of stock, bonds, and even more complicated financial instruments. In theory, diversification reduces risk because as one kind of stock loses value, another kind gains value. Total market index funds, the most widely diversified, own the stock of every company in the U.S. stock market. Your fortunes then rise or fall in synchrony with the entire economy.
Most funds are more selective.
Some are riskier because they invest in stocks that wildly fluctuate in price. Always invest in funds that match your investment goals and your comfort level for risk. Investors can further reduce their risk by purchasing a group of funds with different investment goals. But avoid buying funds that duplicate the holding of funds you already own. One possible combination might include a foreign stock fund, an aggressive growth fund, a growth and income fund, and a bond fund.