As the number of exchange-traded funds has exploded in recent years, more investors are turning to them for lower fees and niche exposure. Some analysts say that’s also because of underwhelming performance in many actively managed funds. According to recent data from Bloomberg, only four of Janus’ 20 biggest stock-oriented funds beat their one-year benchmark for the period ending on Jan. 24. American Funds also saw outflows of $81 billion last year, including $33 billion of outflows from its American Funds Growth Fund of America.
In the growing war of mutual funds versus ETFs, analysts and advisers say that both have their advantages. Employing ETFs for indexes and niche market exposure while using mutual funds for active management and diversification means both can coexist in the same portfolio.
Because they don’t have active management, lower costs and expenses have often been one of the biggest draws for ETF investors. According to Russel Kinnel, director of mutual fund research at Morningstar, the average mutual fund investor paid 0.75% in expenses in 2011. This is a small decrease from 0.77% in 2010 and over the past decade, expenses have fallen by about 19 basis points. In a post at the company’s website, Kinnel said that expense ratios have come down because of appreciation, inflows and a shift to lower-cost funds.
Although there’s no data to support the trend, analysts say it’s likely that at least part of the growth in ETFs can be attributed to some investors leaving mutual funds in search of lower expenses. Expense ratios for equity ETFs typically average between 0.3% and 0.55%, almost half that of most mutual funds. And as most investors know, expenses can have a major impact on return over time. If one were to invest $30,000 in a fund and average a 7% return over 25 years, the future value would be $163,000. But an additional 0.5% expense ratio would net a future value of just $145,000, 11% less.
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