A built-in advantage: diversification. One of the main advantages of investing in a mutual fund is that a fund is essentially a collection of different investments -- which helps you diversify your portfolio to reduce the risk associated with market fluctuations.

Make informed decisions about mutual funds. Over the past decade, American investors increasingly have turned to mutual funds to save for retirement and other financial goals. Mutual funds can offer the advantages of diversification and professional management. But, as with other investment choices, investing in mutual funds involves risk. And fees and taxes will diminish a fund's returns. It pays to understand both the upsides and the downsides of mutual fund investing and how to choose products that match your goals and tolerance for risk.

What is a Mutual Fund?

A mutual fund is a professionally managed investment option. It pools money from groups of individual shareholders and invests in a portfolio of stocks, bonds and cash. A portfolio manager invests in the fund according to the fund’s prospectus, which describes the fund's objectives, history, financial statements and manager’s background. To understand a mutual fund, you must first become familiar with a mutual fund's underlying investments: stocks, bonds, and cash equivalents.

• Stocks are ownership shares of a corporation.

• Bonds are certificates of debt or negotiable promissory notes of a corporation or public body that promises to pay periodic interest until a maturity date when the debt will be repaid.

• Cash equivalents are short-term investments with a high degree of safety that can be converted to cash quickly, such as T bills and money market securities.