Individual stocks or bonds can often be quite risky. If you look at an individual stock such as Tesla (TSLA), you will notice it has gone from quite the wild ride in the last few years. The highs are high but the lows are also low. A common practice to attempt to lower the swings is to diversify in different assets or in the case of stocks, different companies.
This can create complexity in a couple of ways. First, it can be difficult to pick which stocks will combine to give you a good balance between being diverse but also maximizing your return. Another roadblock you may run into would be not having enough cash to create your ideal strategy. Say for example you have $1,000 to invest. If the stocks you are looking to invest are all hundreds of dollars then you could likely only buy a few of them.
One of the the most common types of pooled funds would be a mutual fund. This is where a group of investors all put their money into the same fund for a fund manager (someone hired to oversee what stocks/bonds/other assets make up the fund) to control. When you get a large amount of investors all contributing money, it allows for many more options to buy a large amount of different stocks. It allows you to buy into a lot of different companies with a relatively small sum of money.
There are also index funds, which are popular with some investors. Created by Jack Bogle, index funds track an index, such as the popular Standard and Poor (S&P) 500. This index holds 500 of the leading companies in the U.S. stock market. In a index fund, instead of a fund manager making decisions on what goes in or out of a fund he/she would builds it to mirror what is in the referenced index.
Mutual funds all have costs to keep them running and these are passed along to the investor in the form of an expense ratio which is typically a percent. If you expense ratio is 0.6% then you would paying $0.60 for every $100 you invest in the fund per year.
Now that we understand what a mutual fund is and what it costs, let's move on to how we use this helpful tool when creating our investment portfolio.