The Globe and Mail

Personal finance writer Gail Bebee and the winner of our investing quiz, whom we can identify only as Steve, are into their second week of mentoring. This time, Ms. Bebee writes him a letter detailing how to pick a mutual fund or exchange-traded fund.

Dear Steve,

Discount brokerage accounts offer direct investors a cornucopia of choice. This week we will begin a tour of what is on offer in your new iTrade account. Let’s start with mutual funds, since they are the first introduction to the world of investing for so many Canadians, including you. If your recent negative experience with mutual funds has you running for cover, don’t dismiss them just yet.

A mutual fund is financial product. The company offering a fund pools money from many individuals and invests the money according to specific objectives. Depending on its objectives, holdings in a fund could include such asset classes as cash/cash equivalents, bonds, stocks real estate and commodities. The typical mutual fund portfolio manager actively buys and sells investments for the fund. Mutual funds are sold in units, do not trade on a stock exchange and are usually priced at the end of every day. Discount brokers sell only Canadian registered mutual funds which can usually be bought and sold without sales commissions.

Investor Education on mutual funds: What will it cost to invest in mutual funds? Feeling ripped off, investors? You're not alone Should I buy my mutual funds from the same fund company? How do I sell mutual funds? How do I put more money in my mutual funds?

Exchange-traded funds or ETFs also pool investors’ money and invest according to defined objectives, again with a broad choice of possible investments. The fund manager seeks to track the performance of a specific benchmark index e.g. S&P/TSX 60 Index, by buying and holding the assets that make up the target index. This approach is often referred to as passive fund management. Because ETFs trade on stock exchanges, you’ll be able to buy both Canadian and U.S. registered ETFs. This also means you pay a sales commission to buy and sell ETFs and the price varies throughout the trading day.

Investor Education: All about ETFs How to make ETFs part of your RRSP The bad boys of the ETF world Are ETFs your cup of tea? How do ETFs fit my investment strategy at this stage in life? How do Exchange-Traded Funds (ETFs) work?

Both mutual funds and ETFs provide an easy way for you to own a diversified investment portfolio personalized to your risk profile, even if your portfolio is relatively small. Mutual funds are a convenient and cheap way to invest small amounts of money on a regular basis, e.g. saving via automatic withdrawals from every paycheque. ETFs, on the other hand, yield better investment performance than most equivalent mutual funds, are cheaper to own and are more tax efficient.

Gail Bebee's Investing Mentor program: How much risk can you stomach? Ask Gail Bebee How to pick a fund Diving into direct investing How to invest $10,000

Your homework for this week involves investigating mutual funds and ETFs in more depth.

• Visit www.getsmarteraboutmoney.ca and check out the mutual funds and ETFs section under the Investing header on the left side of the Home Page.

• Read chapters 14 and 15 in the copy of No Hype-The Straight Goods on Investing Your Money which I entrusted Canada Post to deliver to you.

• Read Part 2: The all-in-one investment solution that could be for you, Part 3: A guide to buying your own mutual funds and Part 4: ETFs: easy, tax-efficient funds of my Globe Investor series on New to direct investing?.

• Tour the web sites of the Canadian suppliers of unleveraged ETFs:

- Barclays Global Investors which owns the iShares™ brand

- Claymore Investments

- Bank of Montreal

• Visit Globe Fund and try out the fund filter feature for the Canadian Equity asset class. Select a mutual fund and an ETF which you would consider purchasing with part of your $10,000 prize. Your filter criteria should include highly rated, low-fee funds with a reasonable investing minimum. Go to the web sites of the companies offering your chosen funds and read what they say about the funds you’ve picked. If you are really keen, open up the fund prospectus and take a look.

For investors who have more time for research and the inclination to take a more hands-on approach to investing, discount brokers also offer the ability to directly purchase many of the investments you’ll find inside mutual funds and ETFs. In next week’s lesson, we’ll investigate some of these—cash/cash equivalents, bonds and stock.

Gail Bebee is the author of No Hype – The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is gailbebee.com