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Financial advisors will soon — and for the first time — hold more of their clients’ assets in exchange-traded funds than in mutual funds, according to a new report by Cerulli Associates.
Nearly all advisors use mutual funds and ETFs, about 94% and 90% of them, respectively, Cerulli said in a report issued Friday.
However, advisors estimate that a larger share of client assets, 25.4%, will be invested in ETFs in 2026 relative to the share of client assets in mutual funds, at 24%, according to Cerulli.
If that happens, ETFs would be the “most heavily allocated product vehicle for wealth managers,” beating out individual stocks and bonds, cash accounts, annuities and other types of investments, according to Cerulli.
Currently, mutual funds account for 28.7% of client assets and ETFs account for 21.6%, it said.
ETFs and mutual funds are similar. They are 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 roughly $10 trillion of U.S. assets. While that is about half the roughly $20 trillion in mutual funds, ETFs have steadily eroded mutual funds’ market share since debuting in the early 1990s.
“ETFs have been attractive for investors for a long time,” said Jared Woodard, an investment and ETF strategist at Bank of America Securities. “There are tax advantages, the expenses are a bit lower and people like the liquidity and transparency.”
Lower taxes and fees
ETF investors can often sidestep certain tax bills incurred annually by many mutual fund investors.
Specifically, mutual fund managers generate capital gains within the fund when they buy and sell securities. That tax obligation then gets passed along each year to all the fund shareholders.
However, the ETF structure lets most managers trade stocks and bonds without creating a taxable event.
In 2023, 4% of ETFs had capital gains distributions, versus 65% of mutual funds, said Bryan Armour, director of passive strategies research for North America at Morningstar and editor of its ETFInvestor newsletter.
“If you’re not paying taxes today, that amount of money is compounding” for the investor, Armour said.
Of course, ETF and mutual fund investors are both subject to capital gains taxes on investment profits when they eventually sell their holding.
Liquidity, transparency and low fees are among the top reasons advisors are opting for ETFs over mutual funds, Cerulli said.
Index ETFs have a 0.44% average expense ratio, half the 0.88% annual fee for index mutual funds, according to Morningstar data. Active ETFs carry a 0.63% average fee, versus 1.02% for actively managed mutual funds, Morningstar data show.
Lower fees and tax efficiency amount to lower overall costs for investors, Armour said.
Trading and transparency
Investors can also trade ETFs during the day like a stock. While investors can place a mutual fund order at any time, the trade only executes once a day after the market closes.
ETFs also generally disclose their portfolio holdings once a day, while mutual funds generally disclose holdings on a quarterly basis. ETF investors can see what they are buying and what has changed within a portfolio with more regularity, experts said.
However, there are limitations to ETFs, experts said.
For one, mutual funds are unlikely to cede their dominance in workplace retirement plans like 401(k) plans, at least any time soon, Armour said. ETFs generally do not give investors a leg up in retirement accounts since 401(k)s, individual retirement accounts and other accounts are already tax-advantaged.
Additionally, ETFs, unlike mutual funds, are unable to close to new investors, Armour said. This may put investors at a disadvantage in ETFs with niche, concentrated investment strategies, he said. Money managers may not be able to execute the strategy well as the ETF gets more investors, depending on the fund, he said.
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