Excerpted from Bogle on Mutual Funds by John C. Bogle, pages 53-54

The third principle of mutual fund investing is liquidity. Mutual fund shares may be acquired or liquidated at a moment's notice at the fund's next determined net asset value per share. What is more, there is no direct cost of market impact, wherein buying securities tends to drive prices higher and selling securities tends to push prices lower. Nor is there a charge when shares are liquidated (although in some cases a 1% redemption fee is charged and in other cases a contingent deferred sales load may be assessed).

Owning securities individually, of course, is also apt to provide a reasonable level of liquidity. However, mutual funds can easily be converted into cash at a fraction of the cost you would incur in selling individual stocks or bonds. More, the ability to switch easily among different investment options provides remarkable flexibility in building a diversified portfolio, especially considering the costs involved in exchanging individual securities.

For instance, if you want to exchange, say, $10,000 of stock A for $10,000 of bond B, you might pay a brokerage firm a commission of about 2% to sell the stock (after having already paid a commission to purchase the stock) and an effective commission of about 1% to buy the bond. Shifting your allocation from stocks to bonds would cost you about $300, an expense that would be repeated each time you made an exchange. But if you were to request a similar exchange from a stock mutual fund into a bond mutual fund and you were moving between funds within the same no-load family, the transaction would cost you nothing.