According to the Investment Company Institute (ICI), mutual funds make up more than 67% of all American retirement assets and continue to be a vital part of the investment portfolios of 90+ million people.

Like all investments, mutual funds have their risks, so it's important to know the essentials before investing.

Here are five questions to ask before investing in a mutual fund:

1. Does the Mutual Fund Add Diversification to Your Portfolio?

Diversification is one of the best aspects of mutual funds. Upon investing in a fund, your dollars can be instantly spread across dozens of companies, sectors or even countries.

But before you add another mutual fund to your portfolio, be sure and read the fund's prospectus to see the fund's 'top holdings,' which will display the companies, security types, sectors and/or countries that the fund is heavily invested in. If you already own the companies held by the fund, don't buy it. Investing in a fund that tracks companies you already own will not help increase your exposure to different investments and will only magnify your portfolio's risk should the market fall.

If you are younger with a longer time horizon, your portfolio should consist of mostly stock funds for greater growth potential. As you get closer to retirement, invest a greater percentage of your portfolio dollars into safer funds (such as bond and money market funds) with less growth.

[InvestingAnswers Feature: Diversified Investments: Beginner's Guide to Protecting Your Nest Egg.]

2. Does the Mutual Fund Offer Low Fees and Expenses?

Look closely at all of the fees and expenses associated with the fund so you know how large of a bite you can expect to be taken out of your returns. According to ICI, the average stock fund expense ratio was 1.45 percent in 2010.

While you're looking at the prospectus, check to see if the fund has a 'sales load.' This is money taken out of your investment either before (front-end load) or after (back-end load) you make it.

For example, if a mutual fund carries a 5% load and you invest $1,000, $50 will be taken out before the $950 is invested.

Let's look at how a fund with a 5.75% sales load and a 2.0% total expense ratio compares to an investment without fees. We'll assume a 10% annual return on a $25,000 investment for 20 years:

Mutual Fund Fee Table

Fund A (without fees) grew to a balance of nearly $58,000 more than Fund B in just 20 years!

If a fund has high loads or fees, look for a comparable no-load mutual fund or an index fund to minimize expense and maximize your investment dollars.

3. Does the Mutual Fund Have a Good Track Record?

A fund investor's aim is to get the highest return with the least risk. But even the smartest investors make the mistake of only looking at a fund's past performance.

If you find a fund with strong past performance, see if the fund's current portfolio manager was at the helm during the period or if the fund strategy has changed; otherwise you can't be sure whether or not the fund will have future success.

Also look for funds with a long track record (15 years or more is best) of steady success rather than a two-year hot fund that could fizzle out down the road.

4. Is the Fund Tax-Efficient?

Mutual fund investing outside of a retirement plan can cause huge tax headaches without the consideration of one key factor: capital gains distribution. A fund must make capital gains distributions to shareholders (at least once annually) if it makes a net profit from selling securities. Upon receipt of the distributions, shareholders must pay capital gains tax on the amount.

To see how tax-efficient a fund is, look at the fund's turnover rate (found in the prospectus), which will tell you the fund's trading frequency. The lower the turnover rate, the lower the capital gains distribution (and tax liability). The average stock fund turnover rate is 53% according to ICI, but many stock funds offer a much tax-friendlier rate of 35%.

See when the fund makes its annual capital gain distributions and consider whether the distribution will add to your tax liability. You may save considerably on taxes by waiting to buy the fund after the distribution is paid.

5. Are the Share Class Types Right for Me?

Mutual funds can come in three share classes: Class A Shares, Class B Shares or Class C Shares. Each share class has the same portfolio, objectives and policies but will have different shareholder services, fees and expenses.

Get projections of growth and expenses to see which class of fund is the best choice for you. These small differences can have a massive impact on performance results.

The Investing Answer: Good mutual funds are the bedrock of a successful retirement or investment portfolio. The best funds will match your investment strategy, offer low fees, and deliver solid, tax-friendly returns that will build your wealth for years to come.