The vast majority of American investors do so through mutual funds, but that trend seems to be changing for the better because investing for the masses is getting a lot cheaper.
Data from 2016 indicated that over half of U.S. households invested in mutual funds and the industries total assets under management were $16.34 trillion at the end of the year. Over the past few years net cash inflows to mutual funds have been shrinking and even turned negative in 2015. In 2007 cash inflows to mutual funds hit an all-time high at $879 billion, which makes sense because this was the peak of the market before the crash caused by the housing crisis. In 2009, 2010, and 2011 cash inflows were negative, -$146 billion, -$282 billion and -$96 billion respectively.
In 2012 cash in-flows returned positive and hit $200 billion, but the industry has seen declining in-flow ever since; $177 billion in 2013, $104 billion in 2014, a negative $101 billion in 2015 and even worse a negative $229 billion in 2016.
It was easy to see and understand why mutual funds experienced cash flow decline in 2008, 2009, and 2010 as the market was falling and investors were scared. But the fact that less money is moving into mutual funds while the stock market in general has increased the past few year's means there is likely a larger force at play.
The argument could be made that more baby-boomers are retiring and thus pulling more money from these accounts causing the cash flow to turn negative. There are also other reasons such as global economic slowdown's, terror-related factors and wars raging or just a general concern due to political disagreements from all around the world, just to name a few. But the fact of the matter is that these outside forces have always been present and the industry had done just fine.
I believe, and evidence supports my case that investors are finally, after years of being preached to, learning that a mutual fund is not likely the best place to invest your hard earned money!
The main reason for that is the fee's mutual funds charge their clients. I will say it again because it is that important, the fee's mutual funds charge you are ridiculous and unnecessary.
This realization from the general investing world has led investors to move their money from mutual funds into Exchange Traded Funds in a rapid way. As we have seen the declining cash flows in mutual funds, Exchange Traded Funds have seen increasing cash flows.
In 2016 net cash inflows into ETF's hit a record $287.5 billion, a time when mutual funds saw $229 billion flow out. Furthermore, it would appear 2016's record in-flow for ETF's wasn’t just a fluke. Over the past 12 months ETF's have seen $466.4 billion flow in. The new money rolling into ETF's has now made the once non-existent industry a $3 trillion player.
The best explanation for the transition from mutual funds to ETF's is the lower costs. A mutual fund that tracks the S&P 500 index is going to perform the same as an ETF such as the SPDR S&P 500 ETF (PACF:SPY) which tracks the same index, except the mutual fund investor is going to see a slightly lower return rate because of the costs.
SPY costs an investor a really low price of just 0.09% per year while the average ETF charges 0.53%, still ridiculously low compared to the average mutual fund will cost you 1.42% per year. But there are even cheaper options than SPY such as the iShares Core S&P 500 ETF (PACF:IVV) which charges 0.04% or the Vanguard S&P 500 ETF (PACF:VOO) which has the same expense ratio.
Over the past 10 to 15 years investors have become much more educated about investing and what it costs them. While 1% may not sound like much, if you have a $100,000 portfolio that is $1,000 or $5,000 if you have managed to save and grow your money to a half a million. That size of a portfolio would have likely taken decades to build, and it's even more likely that in the beginning that investor was only putting say $5,000 a year into the account. So to think now that the fund that the money has been growing in is charging you once put into the account in an entire year is crazy.
On top of the fact these funds are taking huge chunks of money, the real issue is the missed compounding return. The biggest reason portfolios grow to hundreds of thousands of dollars over decades is because of compounding returns, not the amount of money you are shoveling into the account each year. So when your fees are high, that is less money that can be compounded year after year after year. And in the end, your overall next egg portfolio is much smaller than it would have been if you hadn’t paid those high fees.
While ETF's offer plenty of other benefits besides low fee's, it is hard to argue that any of the other benefits would outweigh the low costs of Exchange Traded Funds, especially when compared to their mutual fund counterparts.
Disclosure: This contributor did not own shares of any equity mentioned above. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.