NEW YORK (MainStreet) — October marked the sixth straight month that investors withdrew money from mutual funds, and experts say that's because exchange-traded funds (ETFs) earn out more money than mutual funds over time.
"Mutual funds are going out of style to be forever replaced by exchange traded funds," said Brock Moseley, founding partner of Miracle Mile Advisors in Los Angeles.
The total net assets of ETFs reached $1.8 trillion in June 2014, according to the Investment Company Institute, compared to $595 billion in outflows from domestic equity mutual funds.
"Mutual funds have ceded ground, because ETFs trade every second of the trading day whereas mutual funds only trade daily, so there's more liquidity with ETFs than mutual funds," said Duncan Rolph, managing director with Miracle Mile Advisors.
A structured product, buying and selling doesn't impact the tax liability of an ETF and shares cost less, because ETFs are passively managed.
"The management fees included in a mutual fund are often significantly higher than the internal fee of an ETF, because the manager is often trading in and out of holdings," Rolph told MainStreet.
According to Morningstar, the expense ratio for ETFs is an average of a quarter of a percent compared to 1.2 % for mutual funds.
"Investors are getting more from their investment in ETFs on an after fee and after tax basis because lower fees enable investors to keep more of what they earn in returns," Moseley told MainStreet.
And while most mutual funds require active managers to select holdings inside the fund, ETFs are passively managed because they typically track indexes, which are benchmarks with set holdings.
ETFs have been so successful that brand name mutual fund firms are following suit by launching ETF versions of their mutual funds.
"Large mutual fund companies are creating their own ETFs because if you can't beat them, why not join them," said Rolph. "They are creating ETFs to mirror their existing mutual fund products."
For example, PIMCO, the famous mutual fund firm that invests in bonds, offers 17 ETFs including its first the PIMCO Total Return ETF (BOND)
"PIMCO's bond ETF outperformed their mutual fund, bringing notoriety to the structure and performance of ETFs," Rolph said.
However in all their glory, ETFs continue to lag mutual funds in one specialized corner of the investment world.
"401(k) plans are the last bastion of mutual funds because many are managed by mutual fund companies and they are not keen to convert those clients' mutual fund portfolios to ETFs," Moseley said.
Staffers stuck at companies who do not offer ETF options can set up an IRA to gain additional returns from ETFs or lobby human resources to add ETF alternatives.
"We're seeing a lot of ETF only 401(k) plans coming about through TD Ameritrade, and ETFs are gaining market share because financial advisors are using them more," said Moseley
Miracle Mile Advisors maintains 15 ETFs in its overall portfolio including the Super Preferred Fund (SPFF), which invests in a line up of financial companies such as Wells Fargo.
"It's tax efficient and pays a 7% yield," Moseley said. "Its dividends are recognized as qualified so investors pay 30% in taxes not 50%."
Written by Juliette Fairley for MainStreet