Financial services companies have offered mutual funds for over 200 years. These innovative products are typically comprised of a basket of assets that can include corporate bonds, bank-issued securities and market-traded equities. Today, most mutual funds include a mixture of stocks and other financial instruments designed to produce stable returns.
The value of most mutual funds fluctuates less than that of newer investment vehicles like exchanged-traded funds and index funds. Mutual funds typically underperform the broader market during bull market cycles and overperform it during bear market cycles. Since these funds are designed to be attractive to long-term investors, they tend to smooth out month-to-month market volatility. Over a 10-year period, the performance of the average mutual fund is likely to mirror that of the broader market.
There are hundreds of financial companies that issue and promote mutual funds. Each company's investment philosophy is different. Those that focus on stable American companies that pay healthy dividends may produce predictable annual returns without ever producing the eye-popping numbers favored by some medium-term investors. Financial companies that prefer to invest in developing countries or commodities prone to boom-and-bust growth cycles may experience excellent returns one year and terrible losses the next.
Investors who look to ride these aggressive funds as they appreciate understand that market timing is important. Shareholders who ignore the market's warning signs and retain ownership of rapidly-depreciating funds may take years to recover their losses. Then again, research indicates that shareholders who reinvest in struggling funds after significant drops in value outperform shareholders who panic and sell their holdings for a loss.
The typical mutual fund's average annual return will vary according to the broader market's performance during a specified time period. Over very long periods of time, most mutual funds return no more than 8 to 10 percent per year. Over shorter time frames, some mutual funds may produce far more impressive returns. During wild market bounces, certain well-positioned funds may double in value within a year's time.
Despite their relatively attractive rates of return, mutual funds come with some important drawbacks. For starters, fund issuers charge ongoing management fees that may reduce rates of return by 1 to 2 percent each year. Some issuers even charge "load" fees that reduce the fund's value by 3 to 5 percent at the point of sale. In addition, the fairly conservative S&P 500 outperforms many mutual funds over the long term.