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ETFs Poised to Overtake Mutual Funds in Financial Advisors' Portfolios

For the first time, financial advisors are expected to allocate more client assets to exchange-traded funds (ETFs) than mutual funds by 2026, according to a report by Cerulli Associates. Currently, mutual funds account for 28.7% of client assets, compared to ETFs at 21.6%. However, advisors project that ETFs will rise to 25.4% of client portfolios, surpassing mutual funds, which are expected to drop to 24%.

This shift could make ETFs the top investment vehicle for wealth managers, outpacing other asset classes like individual stocks, bonds, and cash accounts.

If you look at current figures, you’ll see that ETFs hold about $10 trillion of U.S. assets, which is nearly half when compared to mutual funds.

Why ETFs Are Gaining Popularity
ETFs and mutual funds share similarities, offering investors diversified exposure to a range of securities. However, ETFs have been giving tough competition to mutual funds since their debut, thanks to key advantages:

  1. Tax Efficiency: Unlike mutual funds, ETFs allow managers to trade without creating taxable events for investors. In 2023, only 4% of ETFs distributed capital gains, compared to 65% of mutual funds.

  2. Lower Costs: ETFs typically have lower expense ratios than mutual funds. Index ETFs average 0.44% in annual fees, while index mutual funds average 0.88%, according to Morningstar. Active ETFs also cost less, at 0.63% versus 1.02% for their mutual fund counterparts.

  3. Liquidity and Transparency: ETFs trade like stocks, allowing investors to buy or sell throughout the day. They also disclose portfolio holdings daily, unlike mutual funds, which update quarterly.

These features provide lower overall costs and greater flexibility, making ETFs increasingly attractive to financial advisors and investors alike.

Limitations of ETFs
Despite their growing appeal, ETFs face limitations. Mutual funds remain dominant in workplace retirement plans like 401(k)s, where tax advantages of ETFs offer little additional benefit. Moreover, ETFs cannot close to new investors, which can hinder performance in niche strategies as more money flows into the fund.

As ETFs continue to gain ground, their tax efficiency, lower fees, and transparency are reshaping how financial advisors manage client portfolios, though mutual funds still retain a stronghold in specific areas.

Why retirees should choose ETFs

Exchange-traded funds (ETFs) offer various benefits, including embedded diversification, which helps spread risk across a broader set of investments compared to picking individual stocks. Additionally, ETFs typically come with lower expense ratios than actively managed mutual funds, making them a cost-effective option for long-term portfolios.

Furthermore, ETFs offer greater flexibility as they can be traded on an exchange throughout the day, just like stocks. This feature is particularly useful for making timely portfolio adjustments or rebalancing as market conditions change.

The variety within the ETF market is another key advantage. Retirees can choose from funds focused on income-generating strategies, sector-specific themes such as healthcare or technology, or broader asset classes to align with their goals. Whether the objective is steady income, capital preservation, or moderate growth, there’s likely an ETF that fits the bill..

Best ETFs for retirement

Investing for the long term requires a careful balance of diversification, low costs, and growth potential. Here’s a look at five exchange-traded funds (ETFs) that can help build a strong foundation for your portfolio, spanning domestic small caps, international stocks, and high-dividend opportunities.

For investors seeking a comprehensive approach to U.S. equities, the Vanguard Total Stock Market Index Fund offers exposure to a vast array of companies, from large-cap tech giants to smaller firms across various sectors. This fund is weighted by market capitalization, giving prominence to companies like Apple, Microsoft, Nvidia, and Amazon, which have driven market gains in recent years.

VTI is a passively managed fund, keeping costs to a minimum with an expense ratio of just 0.03%. The broad diversity of holdings ensures that while the fund leans toward tech, it also includes hundreds of stocks from other industries, which can stabilize returns during market downturns. Given its broad market exposure and low costs, VTI is an ideal choice for dollar-cost averaging, allowing investors to build wealth steadily over time.

For those looking to tap into the potential of smaller companies, the Schwab U.S. Small-Cap ETF is a standout option. With an average market capitalization of $3.7 billion and approximately 1,750 holdings, this fund offers exceptional diversification within the small-cap space. Its balanced sector exposure, with industrials, technology, and financial services each comprising about 16%-17% of assets, provides stability in what can otherwise be a volatile segment of the market.

Notable companies in the portfolio include innovative firms like Duolingo, BWX Technologies, and Stifel Financial. The low expense ratio of 0.04% further enhances the fund’s appeal, making it an excellent long-term investment choice for those seeking growth potential among small-cap stocks.

For investors interested in income generation alongside international market exposure, the Vanguard International High Dividend Yield ETF is a top choice. This fund offers access to globally recognized companies such as Nestle, Novartis, and Unilever, while delivering a robust dividend yield of 4.6%, significantly higher than the 1.8% offered by many U.S.-focused funds.

With a low expense ratio of 0.22%, this ETF is a cost-effective way to diversify geographically and benefit from high-income streams. Its combination of growth and income potential makes it particularly attractive for retirees or those seeking steady cash flow in their portfolios.

For investors focused on high-yielding U.S. stocks with strong financial health, the iShares Core High Dividend ETF stands out. The fund holds 74 carefully selected companies that pass quality screens for dividend sustainability and balance sheet strength. Its 3.4% dividend yield provides a consistent income stream, appealing to those seeking passive income.

The fund also boasts a five-year annualized return of 7.4% and a beta of 0.66, indicating lower volatility compared to the S&P 500. This makes HDV a great complement to a portfolio that already includes broad-market ETFs like VTI, offering both income and stability.

To achieve a truly diversified portfolio, exposure to foreign markets is essential, and the Vanguard Total International Stock ETF provides just that. With over 8,600 holdings, the fund spans regions across the globe, from Japan and the United Kingdom to emerging markets like China.

The portfolio includes a mix of established leaders, such as Taiwan Semiconductor Manufacturing and Novo Nordisk, alongside smaller emerging-market players, making it a balanced choice for international diversification. Its expense ratio of 0.08% ensures cost-effectiveness while delivering access to the growth potential and stability of global markets.

Building a Long-Term Portfolio

Each of these ETFs offers unique advantages, whether you’re seeking broad market exposure, international diversification, income generation, or small-cap growth. Combining them in your portfolio can provide the diversity, stability, and growth potential needed to achieve long-term financial goals, all while keeping expenses low and returns optimized.

Here’s an old but interesting video on the topic:

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