ETFs Take Over: Why Investors Are Pulling Billions From Mutual Funds

For decades, mutual funds were the default choice for American investors. If one wanted to build wealth, they would pick a few solid mutual funds, set up automatic contributions, and let them grow.

But that's changing.

Investors are pulling billions from mutual funds and shifting their money into ETFs, which offer lower fees, better tax advantages, and more flexibility.

According to the Investment Company Institute (ICI), increased investor demand for index-based investment products is among the long-term trends affecting mutual fund demand. The report also suggested that some of the outflows from domestic equity mutual funds have gone to ETFs.

So, why are investors making the switch? And what does this mean for the future of the mutual fund industry? Let's dive in.

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Follow The Money

The numbers don't lie, ETFs are winning. Mutual funds lost $388 billion in 2024, their third straight year of outflows, according to data from Morningstar Direct. In the meantime, U.S.-based ETFs raked in over $1 trillion for the first time ever in 2024, according to a report released by Citi Research.

Moreover, ETFs' tax advantages are a big draw since they don't distribute capital gains the way mutual funds do, making them more efficient for investors. Bank of America calculated that U.S. investors have saved $250 billion by investing in exchange traded funds compared to traditional mutual funds, since their inception in 1993, according to a December 2024 report by the Financial Times.

In an interview with Bloomberg, Eric Balchunas, Senior ETF Analyst at Bloomberg Intelligence, said that people have started to realize that they've been paying higher fees for mutual funds when ETFs offer nearly identical exposure at a lower cost.

Why Investors Are Choosing ETFs

Nobody likes unnecessary fees. Traditional mutual funds often have higher expense ratios and capital gains taxes, which can eat into returns. ETFs, on the other hand, are structured to help investors avoid capital gains distributions and keep more of their profits.

Also, one big argument for mutual funds was that active management beats passive investing. But with the rise of active ETFs, that's no longer an issue.

Additionally, unlike mutual funds, which only trade at the end of the day, ETFs trade like stocks. That means investors can buy and sell them at any time during market hours, just like individual stocks.

How Fund Managers Are Responding

Big asset managers aren't sitting idly by as investors jump ship. Some firms are even converting their mutual funds into ETFs.

In the past five years, more than 121 actively managed US funds with total assets of $125 billion switched to an ETF structure, according to a report from last November by the Financial Times. BofA found that of these 121 conversions, the average fund had enjoyed $500 million boost in inflows in the two years after the switch.

For instance, Dimensional has moved billions in assets from mutual funds into ETFs, and others like Fidelity and JPMorgan have followed suit.

Still, mutual funds dominate 401(k) plans and retirement accounts, where ETFs haven't fully broken through due to regulatory hurdles. But that could change soon.

Is This The End of Mutual Funds?

Not quite, at least not yet.

Even though ETFs are growing fast, mutual funds still hold a whopping $22 trillion in assets, compared to ETFs' $8 trillion in 2023, according to ICI data.

Some believe mutual funds will survive in retirement plans, where long-term, automated investing still makes sense. Others argue that direct indexing, where investors can build custom portfolios without ETFs or mutual funds, could be the next big thing.

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