With the file mode the individual VOB and other files are ripped (or copied) to your hard drive, with the ISO mode all will be copied “inside” one big ISO file. This is an ‘image’ of the DVD on your hard drive and can be easily burned to a blank DVD if it fits or opened with some virtual drives like Alcohol 120% or the program you meantioned, Daemon-tools. These create a fake DVD/CD drive what your operating system won’t distinguish from a real one. They can be quite useful for testing purposes for example.
It really doesn’t matter which mode you choose as both won’t lose any quality. However the ISO files are as large as the actual DVDs (meaning that ripping a 9GB DVD with make a 9GB .ISO file) and the very commonly used file system FAT32 has a maximum file size of 4GB so obviously using ISO images is out of the question. Windows versions 95, 98 and ME don’t understand the NTFS file system which doesn’t have this limit so if you are using one of those operating systems the ISO mode is not for you.
It all really depends on what you are planning on doing, ISO mode suits one purpose better than the file mode but for general use the latter might be better. Try it out, can’t hurt
I’m sure you’ll find some more info with Google if you have any more questions.