Mutual funds were supposed to be the savior for amateurs. Spread the risk, diversify across sectors.
Good mutual funds did what they were designed to do. They do spread risk and diversify.
However, the key diversification is asset classes, which diversification usually occurs before you get into any one mutual fund. So, if a person was well diversified among Cash, Bond, U.S. Stocks, International Stocks, and perhaps alternate investment classes (commodities, gold, etc.) then Mutual Funds performed as expected.
Good mutual funds also keep costs low and at least mimic their benchmark. It is rare for any mutual fund to regularly exceed its benchmark.
I will agree with you though that the average dude is not capable of making good portfolio allocation decisions. The only thing worse than stupid people mucking with their 401Ks is people expecting Social Security to pay out. On the whole, I’d prefer people be left with the freedom to make mistakes, rather than centralize assured mistakes in a government somewhere.