Financial advisors are increasingly favoring ETFs over mutual funds, according to a recent report.

• By 2026, for the first time, Cerulli Associates predicts that financial advisors will hold more client assets in exchange-traded funds than in mutual funds.
• Experts said that ETFs typically offer advantages over mutual funds in terms of taxes, fees, transparency, and liquidity.
• It seems unlikely that ETFs will become a significant presence in retirement accounts in the near future.

According to a new report by Cerulli Associates, financial advisors will soon hold more of their clients' assets in exchange-traded funds than in mutual funds for the first time.

Cerulli reported that nearly all advisors use mutual funds and ETFs, with 94% and 90% of them, respectively.

In 2026, it is predicted that a greater percentage of client assets (25.4%) will be invested in ETFs compared to the percentage of client assets invested in mutual funds (24%), according to Cerulli.

According to Cerulli, ETFs are the "most preferred investment vehicle for wealth managers," surpassing individual stocks, bonds, cash accounts, annuities, and other investment options.

According to the statement, mutual funds and ETFs account for 28.7% and 21.6% of client assets, respectively.

ETFs and mutual funds are essentially a legal framework that enables investors to spread their investments across a range of securities, such as stocks and bonds, through diversification.

ETFs have gained popularity among investors and financial advisors due to their key differences.

Since their introduction in the early 1990s, ETFs have gradually reduced the market share of mutual funds, which currently hold approximately $20 trillion of U.S. assets, compared to ETFs' $10 trillion.

"Jared Woodard, an investment and ETF strategist at Bank of America Securities, stated that ETFs have been appealing to investors for a long time due to their tax benefits, lower expenses, and liquidity and transparency."

Lower taxes and fees

Many mutual fund investors are subject to annual tax bills, while ETF investors can often avoid these taxes.

Capital gains generated by mutual fund managers are taxed and passed on to shareholders annually.

Most managers can trade stocks and bonds through an ETF structure without triggering a taxable event.

In 2023, 65% of mutual funds had capital gains distributions, compared to 4% of ETFs, according to Bryan Armour, director of passive strategies research for North America at Morningstar and editor of its ETFInvestor newsletter.

Armour stated that if you're not paying taxes today, that amount of money is being compounded for the investor.

Capital gains taxes apply to both ETF and mutual fund investors when they sell their holdings.

ETFs are increasingly popular among advisors due to their liquidity, transparency, and low fees, according to Cerulli.

According to Morningstar data, index ETFs have an average expense ratio of 0.44%, which is half the annual fee of 0.88% for index mutual funds. In contrast, actively managed ETFs have an average fee of 0.63%, compared to 1.02% for actively managed mutual funds.

Lowering fees and increasing tax efficiency can result in reduced overall expenses for investors, Armour stated.

Trading and transparency

ETFs can be traded like stocks during the day, while mutual fund orders are executed once a day after the market closes.

Experts noted that ETFs typically disclose their portfolio holdings daily, while mutual funds disclose holdings quarterly. As a result, ETF investors have a greater ability to monitor changes in their portfolio with more frequency.

However, there are limitations to ETFs, experts said.

Mutual funds are unlikely to lose their dominance in workplace retirement plans like 401(k)s, at least any time soon, Armour said. ETFs do not provide investors with an advantage in retirement accounts since 401(k)s, individual retirement accounts, and other accounts are already tax-advantaged.

ETFs, unlike mutual funds, cannot close to new investors, which may put investors at a disadvantage in ETFs with niche, concentrated investment strategies. Money managers may not be able to execute the strategy well as the ETF gets more investors, depending on the fund.