Some funds, such as equity income funds or utility funds, invest heavily in stocks that generate dividends in order to produce income for mutual fund investors. Mutual funds may also periodically pay capital gains. As the fund manager sells stocks within the fund, the increase in the price of those stocks, the capital gain, is distributed to the mutual fund investors. Long-term investors usually reinvest their dividends and capital gains by automatically buying more shares of the fund, usually without fees. The fund's total return measures changes in the fund's value, usually on an annual basis, assuming reinvestment of dividends and capital gains.
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.