Investment funds are generally considered the prime initiator and one of the most significant indicators of the level of development of capital markets. A large number of investment funds are active in the global capital market. This facilitates the growth of national economies. The investment funds that have been primarily operating, for more than a hundred years, in developed countries with evolved financial markets are especially noteworthy. These markets are strictly regulated within a legislative framework. Those investors, in the context of these markets, that are able to realize their investment objectives enjoy ever more favorable tax regimes. When compared to the historical development of investment funds in the world, it could be said that the development of the investment fund industry in the Republic of Croatia is in its early stages. The market is driven mainly by banking groups, which dominate the investment fund industry. This work provides the definition, lists the types and explains the characteristics of investment funds. Also, special attention is given to explaining the legal framework within which investment funds operate and to analyzing the performance of investment funds through the measure of return on invested capital. It is a fact that domestic investors can invest in investment funds or directly participate in the capital market. Therefore, we compared the returns of investment funds with the returns of the capital market indexes, as their substitutes. We also tested the performance of equity and bond funds in relation to the two most well-known stock exchange indexes in the Republic of Croatia, namely CROBEX and CROBIS. The results show that mutual funds certainly have the potential to provide investors with above-average returns with diversification advantages. The conclusion, based on the results, is that investors in the current financial environment should seriously consider investing in investment funds, whether equity, bond or mixed, depending on their risk profile.