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Financial advisors will soon — for the first time — hold more of their clients' assets in exchange-traded funds than in mutual funds, according to a new report from Cerulli Associates.
Nearly all advisors use mutual funds and ETFs, about 94% and 90% of them, respectively, Cerulli said in a report released Friday.
However, advisors estimate that a larger share of client assets, 25.4%, will be invested in ETFs in 2026 than the share of client assets in mutual funds, at 24%, according to Cirulli.
If that happens, ETFs will be “the most personalized product vehicle for wealth managers,” beating out stocks, individual bonds, cash accounts, annuities and other types of investments, according to Cerulli.
Mutual funds currently represent 28.7% of client assets and ETFs represent 21.6%, she said.
ETFs and mutual funds are similar. It is essentially a legal structure that allows investors to diversify their assets across many different securities such as stocks and bonds.
But there are key differences that have made ETFs increasingly popular with investors and financial advisors.
ETFs hold nearly $10 trillion in U.S. assets. While this represents about half of the nearly $20 trillion in mutual funds, ETFs have been steadily eroding mutual fund market share since their debut in the early 1990s.
“ETFs have been attractive to investors for a long time,” said Jared Woodard, investment and ETF strategies expert at Bank of America Securities. “There are tax advantages, expenses are a little lower and people like the liquidity and transparency.”
Low taxes and fees
ETF investors can often avoid some of the tax bills that many mutual fund investors incur annually.
Specifically, mutual fund managers realize capital gains within the fund when they buy and sell securities. This tax liability is then passed each year to all shareholders of the fund.
However, the ETF structure allows most managers to trade stocks and bonds without creating a taxable event.
In 2023, 4% of ETFs had capital gains distributions, versus 65% of mutual funds, said Brian Armor, director of North American passive strategies research at Morningstar and editor of the ETFInvestor newsletter.
“If you don't pay taxes today, that amount of money doubles” for the investor, Armor said.
Naturally, both ETF and mutual fund investors are subject to capital gains taxes on investment gains when they eventually sell their holdings.
Liquidity, transparency and low fees are among the top reasons why advisors choose ETFs over mutual funds, Cerulli said.
ETFs have an average expense ratio of 0.44%, half the 0.88% annual fee of mutual funds, according to Morningstar data. Morningstar data shows that active ETFs carry an average fee of 0.63%, versus 1.02% for actively managed mutual funds.
Lower fees and tax efficiency result in lower overall costs for investors, Armor said.
Trading and transparency
Investors can also trade ETFs intraday like stocks. While investors can place a mutual fund order at any time, the trade is only executed once per day after the market closes.
ETFs also generally disclose their portfolio holdings once daily, while mutual funds generally disclose their holdings on a quarterly basis. ETF investors can more regularly see what they are buying and what has changed within the portfolio, experts said.
However, experts said there are limitations to ETFs.
For example, mutual funds are unlikely to give up their dominance in workplace retirement plans like 401(k) plans, at least anytime soon, Armor said. ETFs generally do not give investors an advantage in retirement accounts since 401(k)s, individual retirement accounts and other accounts already have tax advantages.
In addition, ETFs, unlike mutual funds, are unable to approach new investors, Armor said. This could put investors at a disadvantage in ETFs with specialized, focused investment strategies, he said. Money managers may not be able to execute the strategy well because the ETF gets more investors, depending on the fund, he said.
