Mutual funds remain the most popular way for Canadians to save and invest for their financial goals. Although most mutual funds share many of the same benefits (see below), the challenge for investors is to build a portfolio of funds that matches their objectives. Here's a look at why mutual funds are so popular, and how to use them to your advantage.

Why mutual funds?

Professional management. Most of us don't have the time and resources to research the world's markets for investment opportunities. Mutual fund managers do. It's their job to manage money and make day-to-day investment decisions, based on extensive research. This process may include meetings with company executives, competitors, and customers.

Built-in diversification. Most mutual funds typically hold dozens of different individual securities, such as stocks and bonds.

Did you know? Asset allocation refers to how we allocate our savings among the three major asset classes (cash, fixed income, and equities). The mix that's right for you will depend on your goals, time horizon, and comfort level with risk.

Affordability and convenience. Most mutual funds come with low minimum investments, some as low as $100. What's more, after you make an initial investment, you can often make regular contributions with as little as $50 per month.

Automatic reinvestment. Most mutual fund companies automatically reinvest income distributions (from dividends, interest, and capital gains) in additional fund units for you. In a registered Retirement Savings Plan (RSP), this leads to increased tax-free compounding over time.

Your money is not locked in. Mutual funds are highly liquid investments, meaning that it is easy to buy and sell fund units. Should you need your money, you can usually access your funds quickly.

However, fund companies may charge you an early redemption fee if you withdraw your money within three months of purchasing a fund, with the exception of redemptions from money market funds and other "cash-equivalent" funds.

Did you know? Most financial institutions and financial advisors have online tools that can help you determine the kind of investor you are and suggest an asset allocation mix that's right for your personal goals.

Building a portfolio of funds

The challenge is to combine these funds in a way that can help you reach your goals. For instance, many of us probably started investing using a building-block approach - buying one mutual fund, adding another, and then another.

There is nothing wrong with this approach if you are in fact building a diversified portfolio - one that includes equity funds, fixed-income funds, and money market funds.

But if you are just assembling a random collection of funds without considering how they work together to reduce risk and enhance returns, this can take you away from your goals. For instance, some of your funds may overlap and hold similar investments, which might make you less diversified than your realize. And the more funds you have, the harder it is to keep track of them.

Balanced funds are one solution to this dilemma. Balanced mutual funds invest in a combination of stocks, bonds, and short-term cash investments - providing instant diversification in one investment. An experienced fund manager determines the precise mix. Because balanced funds provide exposure to the major asset classes, they can be a good choice for novice investors, or the foundation for a larger portfolio.

Financial tip - Go global with mutual funds. It's difficult for most of us to access more specialized opportunities such as global investments. But large mutual funds have the resources to bring global investing to the average investor.

Portfolio funds, also called "funds of funds," are another way to ensure adequate diversification. These funds combine a number of mutual funds (often from different fund companies) into a single investment. Like balanced funds, their mix includes cash, fixed income, and equities. But unlike most Canadian balanced funds, they also include global investments in their mix - which provides another level of diversification.

You choose a portfolio - income, conservative, or aggressive, for example - that reflects your objectives and risk tolerance, and the portfolios are automatically monitored and rebalanced for you so that they continue to meet your investor profile.

Lifecycle funds are similar to one-stop portfolio funds in that they are a single investment created from other mutual funds (but usually from the same fund family), and they offer a complete asset allocation solution, including global funds, in a single investment.

However, each lifecycle fund is constructed with a specific target date - say, 2020. As the fund's target date approaches, the fund's asset allocation becomes more conservative, with more emphasis on fixed income investments and cash. This makes lifecycle funds a possible choice for investors who have a specific goal in mind, such as sending their kids to university in 2015 or retiring in 2025. It also makes them a possible choice for investors who don't want to spend too much time thinking about their portfolios.

Whether you are using mutual funds to save for your retirement or your children's education, your financial advisor can help you choose the solutions that are right for your situation.

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