Here are the pros and cons of the best Canadian mutual funds and ETFs to help you make the best investment decisions

Mutual funds are diversified portfolios of equities and investments in which small investors can take part. They are an investment product, with individual shares being called units.

Exchange-traded funds hold baskets of stocks that represent stock indexes. ETFs are set up to mirror the performance of those stock-market indexes.

Note that for most investors, we feel that exchange-traded funds (ETFs) offer better value with much lower fees than most mutual funds. So, we feel that most fund investors should shift into ETFs wherever possible.

We also still think that most investors will profit the most by holding a well-balanced portfolio of high-quality stocks. However, if you don’t want to build a portfolio, then ETFs (or mutual funds if you prefer) can provide a good alternative.

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Learn how to invest in the best Canadian mutual funds and you will avoid mutual funds that can lead to losses:

Here are 6 tips to find the best mutual funds:

• Beware of buying vaguely described mutual funds
• Avoid buying mutual funds that trade in derivatives
• Avoid mutual fund managers who trade heavily
• Avoid buying mutual funds with a lot of dead weight
• Avoid buying mutual funds with anonymous managers
• Get out of buying the riskiest “trendy” mutual funds

Buy index mutual funds to get some of the best Canadian mutual funds for long-term performance in your portfolio

Index mutual funds are among the better financial innovations to come along in the past few decades. These are specialized mutual funds that invest so as to come close to equaling the performance of a market index, such as the S&P/TSX 60.

Index mutual funds do show better long-run performance than more than half of all actively managed mutual funds with long-term track records. That’s partly because index fund fees run around 1.0% of assets per year, compared to, say, 2.5% or more on many mutual funds.

One additional advantage of index mutual funds is that they can help you avoid the risk of choosing a fund with a management style that virtually guarantees below-average long-term performance.

Invest in index mutual funds that focus on the right kind of companies and you can keep your portfolio safe

Index mutual funds can provide a low-cost way to invest in the stock market, especially if they track indexes that hold mostly high quality, large-cap stocks. However, as mentioned earlier, for the best long-term returns, we still think you are better off to build a portfolio of well-established companies, spread out across most if not all of the five main economic sectors.

Index mutual funds, in contrast, tend to load up on the hottest, most popular stocks as they rise. That’s because they are typically market-capitalization weighted—and as these stocks rise, they make up a rising proportion of the index. When the indexes go to extremes, so do the index funds. That occurs from time to time, especially in the Toronto market, where some large cap stocks make up a high proportion of the market indexes.

Invest in top ETFs over the best Canadian mutual funds and you should enjoy lower fees

Read these three reasons why ETFs have lower fees than mutual funds:

1. ETFs are less expensive to hold than mutual funds. ETFs give you a low-cost way to invest in a specific market segment. That’s typically cheaper than investing in a mutual fund with a similar focus. With fees as low as 0.10% a year for ETFs vs. mutual funds that can charge you 2% to 3% or higher. ETFs can save you a lot of money over the long term, and boost your return if you are investing over time.
2. ETFs trade on stock exchanges, just like stocks. That’s different from mutual funds, which you can only buy at the end of the day at a price that reflects the fund’s value at the close of trading.
3. Low turnover. Shares are only added or removed when the underlying index changes. As a result of this low turnover, you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional mutual funds pay out to unitholders.

One interesting note about buying mutual funds comes from the Dalbar organization.

This U.S. research firm’s studies of top performing mutual funds show most of their investors who jump in at the top will lose money or make negligible returns. That’s because most investors in a top performing fund only buy into the fund after it has already made big gains. Investors also tend to sell former top performing funds only after a major slump in the value of their holdings. When you chase investment performance, it’s all too easy to buy at the top and sell at the bottom.

Use our three-part Successful Investor approach to select the best stocks—or mutual funds and ETFs that hold those stocks

1. Hold high-quality, mostly dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

What is the worst experience you’ve had with an actively managed mutual fund?