Why are investors moving away from mutual funds to ETFs? Is it all marketing and hype? While it may be difficult to understand the exact motives of the average investor moving from mutual funds to ETFs, one question we can ask is whether investors who own ETF securities actually have more investor knowledge than non-ETF owners. Put another way, are ETF owners smarter than non-ETF owners?
During July of 2019, the Journal of Financial Planning published an article where my colleagues and I asked these questions (Enete et al., 2019). We used the 2015 National Financial Capability Study (NFCS) investor survey, published by FINRA, which asked investment-related questions to 2,000 individuals who owned investments outside of retirement accounts. One of the questions in the survey asked participants whether they owned ETF securities in their non-retirement portfolio. This question allowed us to compare the characteristics (e.g., age, income, education) of the survey participants who owned ETF securities (22% of the 2,000 participants) versus the non-ETF owners. There were also detailed questions about investor knowledge, so we were able to assess whether the ETF investors had more investor knowledge than non-ETF owners, as well.
Our results showed that ETF owners were more likely to be under 44 years of age and non-white. Sex, marital status, education level, and household income did not play a significant role in predicting ETF ownership. In addition, ETF ownership was associated with higher financial satisfaction and higher risk tolerance, as compared to non-ETF owners.
Regarding being smarter, investor knowledge did play a significant role in predicting ETF ownership. Our results showed that, if an investor was able to score just one point higher in their subjective (i.e., “I believe I am smart”) and objective (i.e., “I took a finance test that proves that I am smart”) investor knowledge scales, that would be associated with a 4% and 1% higher probability of owning an ETF security in a participants’ non-retirement portfolio, respectively.
Why did more investor knowledge predict higher ETF ownership?
As explained in our paper, “there are a number of benefits to investing in an ETF product over a mutual fund product, with the most notable benefits being lower capital gain tax payments, lower fees, and improved liquidity. Investors in ETFs should expect to pay lower capital gain tax payments than mutual funds given their trading structure (Kostovetsky, 2003). In addition, ETF investors should expect to pay lower fees since accounting costs are determined at the shareholder level (rather than fund level). ETFs do not have load fees (which tend to be one of the largest fees associated with mutual funds), and ETFs do not have 12b-1 fees (marketing and distribution fees). Finally, ETFs provide investors an additional liquidity benefit, as ETFs share prices allow for intraday values, whereas mutual funds are only priced once-per-day at their net asset value (Enete et al., 2019, p. 44).
While ETFs have many advantageous qualities, it is important to acknowledge that ETFs are not for all investors and also carry some drawbacks. For example, smaller ETFs may have thinner trading and premiums to NAV (net asset value), as well as a commission cost per trade.
Even with considering some of the disadvantages of owning ETFs, it does not undermine the key implications of this study that ETF owners do have more investor knowledge, have higher financial satisfaction, are younger, and have higher risk tolerance levels when compared to non-ETF owners.