Investors can now construct for themselves a personalized basket of stocks in the form of what are called folios, which refers to a set of stocks taken together as a unit. Folios, like ETFs, represent a direct challenge to mutual funds. To date, this challenge is small because this alternative has only recently gotten underway. However, it appears to be catching on with the investing public, and could grow rapidly.

Let's define the folio approach to investing. An investor opens an online account and purchases one or more folios (groups) of stocks that, to a reasonable extent, becomes a substitute for owning a mutual fund. Investors can choose a preselected portfolio constructed by the provider of the service—the so-called ready-to-go option. These preselected portfolios typically have a single focus. Investors can also build a personalized portfolio using various stock screens, or by simply selecting stocks one at a time.

With a mutual fund, you take the whole portfolio, whether you like it or not. For example, if you buy an index fund holding the S&P 500 stocks, you take the entire package even though you might detest a particular stock. With folios, you can do something about a particular stock you do not wish to own. Under either the preselected portfolio alternative or the personalized portfolio alternative, an investor can change a folio anytime by adding or deleting stocks, or changing the amount invested in one or more stocks.

Flexibility is one of the key characteristics of folios. Folios offer investors the ability to fine-tune the portfolio of stocks owned in a way that mutual funds cannot. Think of owning a set of stocks in 2001, which included Enron, and assume that you were smart enough to realize early on that something was wrong with this company. With the folio approach, you could eliminate this stock from your portfolio. When you own a mutual fund, you take the entire package of stocks, for better or for worse.

You can use screening tools and packages alongside the folio approach, thereby identifying stocks that do meet your criteria. You can then eliminate those stocks from the folio.

Investors pay a flat fee for this service and avoid directly paying brokerage costs. This can generate significant cost savings if your investment is large enough because the flat fee is spread across a large investment base. Think of investing say, $500,000 in stocks. Paying regular brokerage costs, even low costs in today's discount online brokerage world could add up very quickly. In contrast, a flat fee of say, $300 a year, calculated as a percentage of $500,000, is cheap indeed at .06 percent of assets.

Folios started out with two providers of this service:

• FOLIOfn was created by a former SEC commissioner. With this service, investors can create a portfolio from scratch. The cost of building three such portfolios of up to 50 stocks each is a flat fee of $295 annually. There is no minimum investment.

• Netfolio, offered by money manager James O'Shaughnessy, required investors to begin with one of its templates, from which individual designs can be constructed. The cost of this service was $200 annually regardless of the number of folios created. The minimum investment was $5,000.

Netfolio subsequently shut down its services, which illustrates an obvious point: Just as the mutual fund industry has its problems, so do some of the alternative services. All are not guaranteed to survive.

Unlike mutual funds, there is no minimum investment amount required to open an account. There also is no minimum trade amount.

With FOLIOfn, you are limited to twice a day in terms of trading, or you can pay an additional fee if you exceed these limits. For example, if you want instant execution, it would cost $14.95. Barring these exceptions, there are no additional costs for using the FOLIOfn services. The twice-a-day trading restriction is not a significant problem for long-term investors.

Folios should get a major boost with the introduction of new providers. Brokers and even banks are likely to begin operations. Investment companies themselves also plan to get into this market. Fidelity, the largest investment company, introduced its product in August 2001.

A major advantage of folios is customization of the portfolio to suit your tastes. Perhaps you wish to overweight one of the stocks in the template called Nasdaq Growth 10 offered by Netfolio. With mutual funds, of course, you must buy the portfolio offered, and the manager makes the decisions. Here, for better or worse, you have the opportunity to make some decisions.

The other major advantage, potentially very important given our previous discussion, is that the investor can take control of the tax situation in terms of timing. He or she can decide to sell an individual stock based on his or her particular tax situation. Other things equal, taking a large capital gain on December 26 or January 2 could make a big difference because in the latter case the tax owed is deferred for another year. Also, an investor can realize a tax loss by selling a stock at a loss, and this can be quite beneficial in certain situations.

Clearly, the flat fee is attractive for those investors who do a certain amount of trading. If you have only a small amount to invest, these are not for you. Consider the percentage cost on a $10,000 investment ($200 / $10,000). However, if you wish to customize and tinker, the flat fee becomes very attractive. Of course, there could be hidden costs here. Perhaps the computer executions by FOLIOfn are not as good as those of the most efficient fund companies. To date, these providers have allowed investors to enter only market orders, thereby denying them the opportunity to use limit orders.

In contrast, with mutual funds, investors have no control over the timing of the distributions short of simply selling the fund, in which case a gain or loss will still be established. If the fund decides to make a large distribution, as many of them did in 2000, the investor has to pay taxes on these distributions despite their other taxable income situation and despite the fact that the share price of the fund might have declined sharply by the time the tax is payable. Finally, a mutual fund is not able to pass on tax losses to shareholders.

Where can investors buy and sell using the folio approach? As noted, FOLIOfn has established an early lead in the field, and is quite well known now in the folio area. Fidelity Investments, the largest investment company in the United Stated in terms of assets under management, now offers its Basket Trading. A basket at Fidelity is a group of up to 50 stocks that can be tracked and traded as one entity. The minimum necessary to purchase a basket is $10,000. Commissions are charged as called for by the type of account the investor has at Fidelity, and there are no additional fees for basket trading. As is true of any folio situation, investors can control the timing and tax implications of their basket transactions.