Investors have a lot of ways to play the stock market these days, but mutual funds are still the most popular investment vehicle, more than 100 years after they first made their way to the United States -- the first American fund, the Boston Personal Property Trust, was formed in 1893.

In Canada, more than $790 billion of our assets are in mutual funds. By contrast, exchange-traded funds (ETFs), or funds that track returns of an index like the S&P/TSX Composite, have about $39 billion in assets under management. But despite their popularity and long history, before you jump into the market, you should know the pros and cons of buying mutual funds. Here are five things you need to know.

1. Mutual funds are good for diversification
Generally, a mutual fund owns a variety of companies. This is a plus because for the most part, the more stocks someone holds, the better -- if one company in a fund falters, but the others stay strong, the fund as a whole should continue to do well.

You can buy funds with varying degrees of diversification. Global funds, which hold companies around the world and in a variety of industries, are the most diversified; sector funds, which hold only stocks in one particular industry, would be considered less diversified because all the holdings are in a single sector.

2. Someone else picks the stocks
Stocks in mutual funds are chosen by portfolio managers who have analysts and research teams scouring the globe, looking for good companies to buy.

Managers themselves talk to company CEOs, scrutinize balance sheets and do all sorts of other things to determine whether a business should be added to their portfolio. It’s almost impossible for the average Canadian to do the research required for stock picking, so many people like leaving it up to the pros. 


3. It costs money to buy
Because of all the overhead costs such as research and staffing, it usually costs a lot more to buy a mutual fund than an ETF. Before you buy, look at the “management expense ratio,” or MER, on the fund. Companies usually charge about 2.5 per cent of your assets to cover their expenses. Many people in the investment industry argue that fees are too high -- the cost makes it difficult to outperform an index, like the S&P/TSX Composite. ETFs, which aren’t under the discretion of a portfolio manager, often have fees under 1 per cent.

4. Funds are large
As much as it costs, it still costs a lot less than if you bought all the funds’ stocks yourself.

Because funds are so big -- many have billions of dollars of assets under management -- managers can buy, essentially, in bulk. That reduces transaction fees and also gives investors an easy way to buy costly companies -- such as Apple, which was trading at $383 a share at the time of writing -- without having to break the bank.  

5. Funds are everywhere
Canadians won’t have to look far to find a good mutual fund. There are thousands to choose from and every bank offers its customers a suite of products.

You can also buy funds through licensed advisers, some of whom work specifically for a mutual fund company, though others are independent and can buy funds from anyone. Do-it-yourself investors can buy funds through online brokerage accounts.

Mutual funds are still the most popular investment vehicle for Canadians and they’re a great place to start for new investors. Talk to a bank or adviser for more information and to find out which funds best suit your portfolio.