As More Investors Choose Lower Cost Exchange-Traded Funds, Why Do Mutual Funds Remain So Popular?

At the start of the millennium, total ETF assets under management in the U.S. sat at around $100 billion but have since hurtled on to reach $7 trillion in 2021. While nothing is certain in investing, the trend of investors pouring more money into exchange-traded funds (ETFs) and pulling cash out of mutual funds continues unabated. 

ETFs have become the darling of financial media, with a chorus of industry pundits sounding the death knell for mutual funds as ETF adoption soars to new levels.  Yet, looking beyond the headlines and to internet traffic paints a different picture. According to Google Trends data, Americans search for mutual funds more often than ETFs.

Before the pandemic, the number of searches for mutual funds was typically double the rate for ETFs. Since the pandemic, the gap has narrowed somewhat, with ETFs typically trailing search volume for mutual funds by less than 50%. However, the notable gap in search volume persists, and ETFs have never registered more search results than mutual funds in any given month.

States where searches for mutual funds are most popular include interior states such as North Dakota, South Dakota, Iowa, Wyoming, and Wisconsin. 

Coastal states lead in interest for ETFs, with Vermont, New York, New Jersey, Colorado, and Florida among the leading states for ETF search volume search queries. However, even in these states, searches for mutual funds still outweigh total searches for ETFs, albeit by a smaller margin.  

The findings raise questions over the appeal of investment vehicles as financial advisors across the U.S. consider what drives interest between the two asset classes.

The Growth of ETFs

ETFs have come a long way since visionary investors like Jack Bogle helped pioneer them decades ago. Launching in relative obscurity in the early 90s, the first funds like the SPDR S&P 500 ETF (SPY) that tracks the S&P 500 Index, moved from relative obscurity to gaining significant momentum in the 2000s. 

The secular trend has reshaped the investing landscape, with ETF issuers like Vanguard and BlackRock emerging as industry giants and releasing an ever more varied stream of new themed funds. However, despite the dizzying growth of ETFs, their main rival – mutual funds – exert staying power.

“Despite the growing popularity of ETFs, mutual funds continue to hold their ground as a preferred investment option for many investors,” says Jorey Bernstein, CEO and Founder of Bernstein Investment Consultants. “The familiarity, range of investment options, and the presence of financial advisors promoting mutual funds contribute to their sustained popularity in today’s world.”

The Dominance of Mutual Funds in 401(k) Plans

ETFs may be favored when individual investors invest their savings independently, but they may be weighted less heavily in employer-sponsored retirement plans like 401(k) plans. Mutual funds remain deeply embedded into the retirement savings vehicles system.

“Most Americans, young and retired, hold their investments in retirement accounts like 401(k) plans. 401(k) plans rarely allow ETFs and primarily use mutual funds for investing, so that can definitely account for more searches for mutual fund tickers than ETFs across all states and even ages,” says Doug “Buddy” Amis, CFP, CLU, and President at Cardinal Retirement Planning.

However, this ongoing reliance on mutual funds could be to the detriment of savers.

Unfortunately, the financial services industry has often relied on more expensive mutual fund share classes for retirement plans (e.g., with higher costs from revenue sharing to cover the plan expenses),” says Amis. “You might be surprised if you search your mutual fund name and find your share class is not only more expensive than ETFs, it is loaded with 12b-1 fees and more.”

Yet fees are what money managers live on, which means many managers are happy to keep things as they are. 

Jonathan Bird, CFP, wealth advisor of Farnam Financial, says the public general ignorance of ETFs is not an accident. “I’ve talked with thousands of investors during my career, and roughly one of five could tell you what ETF stands for or how their trading differs from mutual funds,” he said. “Mutual funds get the most advertising because this is where asset managers generate the highest fees. Follow the money!” 

Could a New Breed of ‘Active’ ETFs Dethrone Mutual Funds?

Active ETFs have been growing as an asset class in recent years as investors move beyond the orthodoxy of purely passive investing that has characterized the ETF movement for decades. Unlike traditional ETFs designed to automatically track the performance of a diverse basket of stocks that infrequently change, active ETFs often invest in fewer stocks traded more frequently by human portfolio managers who decide which stocks to buy.

Lower fees, little to no discounts on net assets value, and streamlined accessibility through exchanges have formed a trifecta of factors that have made these funds alluring more investors, according to Financial Times’ David Stevenson.   

The U.S. leads in ETF adoption compared to other regions like Europe, where most ETFs tend to be heavily concentrated in the ESG (environmental, social, and corporate governance (ESG), and fixed-income space. 

Data from Morningstar shows that capital is flowing into actively managed ETFs faster than passive ETFs and actively managed mutual funds this year.  

“The rise of actively managed ETFs offers a potential ‘third path’ that combines the advantages of mutual funds and ETFs, providing investors more options and flexibility in their investment strategies,” says Bernstein. 

If the sun really does set on mutual funds, most investment industry professionals would rather active ETFs take their place than passive funds. The former’s higher fees (usually 0.5-0.9% per annum) will allow them to keep their nests nicely feathered. 

One thing is clear: the proliferation of new investment vehicles has lowered the cost of entry to investing. It is ultimately to the advantage of investors who have more choice than ever about where to put their money.  

This post was produced by Wealthtender and syndicated by Wealth of Geeks.

Copyright 2023 Wealth of Geeks