The good ol’ mutual fund, that basic investment product that most of us rely on to grow our 401(k) or IRA, is under increasing attack.
Its competition comes from exchange traded funds, which turn 20 years old in 2013 but still draw blank stares from many otherwise savvy investors. Mutual funds and ETFs share the core concept of reducing risk by putting many different investments in one fund. Instead of betting the bulk of your savings on the stock of three or four companies (risky), a single mutual fund or ETF might own hundreds of different stocks (less risky).
Here’s what often sets mutual funds apart from ETFs: fees. The average mutual fund charges a 1.4 percent annual expense ratio, compared to 0.6 percent for the average ETF, according to Standard & Poor’s. That means your $100,000 nest egg loses $1,400 each year to mutual fund fees, but only $600 to ETF fees. The reason for the difference is that many mutual funds are actively managed, and fund managers get compensated handsomely. Most ETFs simply follow an index such as the S&P 500 or the various Barclays Capital bond indexes in order to keep fees lower. How did that work out last year? According to Morningstar Inc., U.S. mutual funds that invested in large growth stocks in 2012 returned a nifty 15.3 percent, but they still couldn’t match similar ETFs at 16.4 percent. Those numbers don’t take fees into account.
“ETFs are becoming more recognized as a standard investment vehicle, and that’s a trend that I believe will continue,” says Teri Hollander Albin, senior vice president at The Hollander Group at Hilliard Lyons in Evansville. “The first thing investors need to look at is the area they are choosing to invest in, and ask, ‘Does it need active management, or is it appropriate to just use a broader benchmark?’”
Mutual funds are far from dead. A growing number simply follow an index, allowing them to mirror ETFs in terms of investments and fees. Also, ETFs might backfire if you regularly put money into a 401(k), because each time you buy or sell an ETF, you pay a brokerage commission. Those commissions may wipe out gains from the lower fees, and as a result, ETFs are not included in many employee-sponsored retirement plans.
Still, it’s hard to overlook the fact that ETFs brought in a record $191 billion in 2012, while investors pulled more than $100 billion from actively managed U.S. stock mutual funds. Those days of ETFs drawing blank stares are just about over. What they’re drawing right now are lots of investors.