Let's not beat around the bush. Mutual funds, with the exception of a money market fund, are similar to stocks. Putting too much money into them can actually be riskier than buying stock, especially if you're not paying attention, because of fund fees, etc. A specific fund also also typically represents an entire sector, so if the sector takes a downturn, your fund goes down.
On the other hand, if you're into mutual funds for longer-term investments, they can be fairly safe, except for the most volatile sectors, and especially if you apply Dollar Cost Averaging (DCA) to get the most out of your mutual fund investments.
The basic principle of DCA works like this:
(1) Make an initial investment into a mutual fund, at whatever unit price the fund is at.
(2) Make long-term regular (e.g., monthly) investments into the fund. Instead of buying the same number of units each month, you buy the same dollar amount.
The net result of the second step is that you get more fund units when the price drops. It doesn't counteract the drop in your total portfolio value, but over time, the spikes in fund price get levelled out. Unfortunately, that's for both ups and downs.
So over a long period of time, you do not get the full advantage of up spikes, but you do dull the down spikes. That means you get a steadier, safer overall interest on your total investment.
Of course, if you choose a poorly-managed fund or one from a volatile industry, DCA may not help you. What you want is to choose funds where their general behaviour is to do well long-term. Which funds are those? If I could tell you that, I'd be rich. However, most honest fund experts agree that the safest long-term mutual funds are index funds.
Index funds are designed to mimic/ follow the stock market. So these are ideal for DCA methods of saving. You know both emotionally and intuitively that unlike a single stock or industry, the stock market is eventually going to recover. While it's down, though, your monthly contribution amount is going to get you more units for the same total price. So when it comes back up, you'll reap the benefits.
Where you'll suffer some attrition from is in fees. There are front-end, back-end and portfolio management fees. The latter is invisible to you, but find a fund with a lower management fee percent. Because the less they take, the more you'll make. Small percentage differences came make a huge difference over many years of compound effective interest.
As for front- and back-end fees, they're paid when you buy into a fund or when you cash out, respectively. If you cannot find a fund you like that does not charge fees, at least go for a fund with just one of these fees.
Obviously, you want to choose a fund with the most beneficial terms. Overall, funds are generally as liquid as a savings account. Keep in mind, though, that some banks and brokerages do not let you quit a mutual fund and then get back into it within a certain time period. (This is not stock trading.) If that happens, you can always place your cash into an online savings account in the interim. (Try something like Emigrant Direct or Ing Direct.)
In terms of drawbacks, funds are not insured by the FDIC like bank accounts and online savings accounts are. On the other hand, you can write off losses against taxes, and fund dividend income is taxed more favorably than regular (non-investment) income.
As for whether a mutual fund is safer or more worthwhile than an online savings account, they can be - if you are a wise, observant investor. Talk to your accountant or an investment advisor to determine if mutual funds and DCA would work for you.
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