Question

Why would a mutual fund, a collection of stocks, bonds, and other securities, have less risk than investing in stocks alone?

a. Stocks are higher risk than most other securities in a mutual fund, but when averaged with the risk of the other securities, mutual fund risk is not as high as stock risk.
b. Mutual funds are controlled primarily by their investors, and those investors would do anything they could to keep their mutual fund from decreasing in value.
c. Because mutual funds eliminate the middle man, there is far less room for error and higher chance for greater profit.
d. Mutual funds, by nature, are a mutual agreement between company and investor, and failure to comply on either side presents repercussions, the fear of which lowers the risk of the investment.

Answer 1

Mutual funds exhibit less risk compared to individual stocks due to diversification, which spreads investment risk across an array of securities. They also offer high liquidity and have the potential for high returns over time, with lower risk and returns relative to individual stocks.

Step-by-step explanation:

A mutual fund, which is a collection of stocks, bonds, and other securities, typically has less risk than investing in stocks alone due to the principle of diversification. When you invest in a mutual fund, you're purchasing a broad range of securities, which spreads your risk across various companies and asset classes. If one stock performs poorly, it may be offset by better performance from other assets within the fund, thereby reducing the impact on the overall investment.

Mutual funds offer high liquidity, which is comparable to that of stocks, meaning you can buy or sell shares of the fund relatively easily if it is readily traded. Moreover, a mutual fund that seeks to track the overall behavior of the stock market is known as an index fund. Investing in mutual funds tends to afford investors a higher rate of return over time, but with lower risks and returns compared to investing in individual stocks due to the pooled nature of fund investments.