Mutual Funds Are Losing Ground To Exchange-Traded Funds, But Remain Dominant In Overall Size And In 401 (K) Retirement Accounts

Topline

While mutual funds have been suffering outflows in recent years as exchange-traded funds (ETFs) attracted record inflows last year, the mutual funds market is still too huge to ignore and remain popular in key retirement packages.

Key Facts

Key Background

During the equity market meltdown in March 2020, investors pulled out a record $336 billion from mutual funds.  Despite the subsequent rally in stocks, mutual funds did not recover, as more investors appeared to favor ETFs. Phil Blancato, CEO of Ladenburg Thalmann Asset Management, which manages $3.5 billion in assets, says mutual funds suffered outflows last year primarily due to their performance issues and high fees. U.S. equity funds saw $241 billion of outflows last year — four times greater than the prior record of $58 billion in 2015 (when markets sold off sharply in August of that year). In contrast, Blancato speculates that bond ETFs have attracted a significant amount of cash partly due to “rebalancing, as investors became scared of the [stock] sell-off we experienced in March leading to the desire to have a more conservative portfolio that has more bonds and less equities.”

What To Watch For

John Rekenthaler, vice president of research for Morningstar, recently wrote that he thinks ETFs will soon “overtake” mutual funds as the most popular investment vehicle for retail investors. Rekenthaler cited a number of advantages in ETFs: namely, they, like stocks, can be traded instantaneously on an exchange at very low or no expense, unlike mutual funds which can only trade once a day (after the market closes), and which require a larger minimum investment. ETFs also boast a tax advantage whereby an ETF’s capital gains and losses are not realized until the investor sells their holdings, while with mutual funds, gains/losses are realized when the fund sells its holdings says Louis Harvey, president of Dalbar, a Boston-based financial services firm. But mutual funds also carry some advantages of their own. Harvey of Dalbar says that mutual funds’ biggest advantages are the public’s familiarity with them (they’ve been around for 100 years, while ETFs launched in 1993); as well as their flexibility: “You can get out of a bad market [with]

mutual funds, [but] ETFs cannot.” Harvey also points out that despite their huge asset size, mutual funds have not become “too big” to keep growing. Rekenthaler says mutual funds will likely “survive on sheer inertia for at least several decades” and that they will likely remain a key part of 401(k) retirement plans “for the foreseeable future.” But Josh Strange, president of Good Life Financial Advisors of NOVA, an independent advisory firm based in Alexandria, Va., says in order to compete with ETFs, mutual funds “have to show their value by either protecting on the downside, or having better upside returns if they want to justify their higher costs.” 

Tangent

Mutual funds continue to play a dominant role in 401 (k) retirement plans – according to the Investment Company Institute, a Washington DC-based association that tracks fund data. As of September 2020, mutual funds held $4 trillion in 401 (k) assets, about 18% of all mutual fund assets. Blancato says that the inherent advantages of ETFs are not as beneficial in a 401 (k) plan. “For instance, intra-day liquidity is not really a concern as retirement assets are typically long-term in nature and clients are not making daily changes to their retirement portfolios,” he says.

Further Reading

How To Invest In ETFs (Forbes)

Top ETFs To Diversify Your Portfolio This Month (Forbes)