Mutual funds automatically provide some level of diversification to investors. This is because these investment vehicles direct capital to multiple equity or bond securities or a combination of both. Nonetheless, there are some mutual funds that invest broadly and provide more diversification than others. Unlike funds that invest solely in financial securities of a certain size, region or industry, diversified mutual funds use a wider set of characteristics when determining where and how to invest.
Diversified mutual funds are designed to protect an investor's assets. Diversification can be achieved in different ways, but could involve investing in industries or asset classes that are non-related. In the event that one group in which a mutual fund is exposed to loses value, those losses have a chance of being offset by the other investment category. Diversification could also involve investing across regions. If one regional economy falters, investment exposure to stronger markets could offset that weakness.
Balanced mutual funds invest in both stocks and bond securities and are considered diversified. In a passively-managed balanced fund, the portfolio remains committed to a certain asset allocation that devotes a given percentage to equities and another percentage to bonds. In an actively-managed balanced fund, which is one in which the portfolio manager trades securities often in response to market and economic conditions, the split between stocks and bonds is more likely to fluctuate.
Risk and Return
Investing in numerous mutual funds that are each devoted to different investment categories achieves diversification. The risk in doing so is that investors wind up overpaying because of the fees due to each individual mutual fund company, according to "U.S. News and World Report." The most diversified mutual funds are not necessarily those that invest in the largest number of stocks and bonds, but instead those that match an investor's ability to handle risk and expected returns.
Investors should take a proactive approach when evaluating asset allocation in mutual funds. Sometimes money managers make decisions that seemingly do not coincide with the investment strategy assigned to a fund, according to CNN Money. As a result, investors should examine the individual financial securities inside a fund and compare it with the composition of some comparable market index to make sure that the fund holds true to its diversification strategy.
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