Markets undergo constant changes and innovation, with the most simple example being the introduction of mutual funds and ETFs. These two changes have helped a bigger portion of the population to invest effortlessly and take part in financial markets. They were not only profitable to affluent investors who were well versed in the financial markets. A look into their historical context helps explain how their introduction altered the state of finance globally.
Roots of Mutual Funds
Investment pooling has been around since the 18th century. The first attempt was made in 1774 by the Dutch merchant Adriaan van Ketwich, who created an investment trust by the name Eendragt Maakt Magt (‘Unity Creates Strength’). He allowed investments into a fund, greatly diminishing risk per investor by allowing diversification. Although this attempt failed, the concept of pooled investments was here to stay. The modern-day mutual fund began with an effort made by three Boston securities executives who established an open-ended mutual fund: The Massachusetts Investors Trust. It was started in 1924 and is known as the first ever open mutual fund. They were not the only investment trust, but they were the first ones to allow an investor to buy or sell shares at Net Asset Value (NAV). It was well received, and by the mid-20th century, its use was ingrained in mainstream America.
The Development and Interest of Mutual Funds
After WWII, mutual fund companies started expanding due to economic development and improving living standards. Some important events include:
- 1940 – The Investment Company Act began the first regulation of mutual funds, which increased the level of trust investors had in them.
- 1971—The first index fund was proposed and sets the stage for passive investment strategies.
- 1976 – Vanguard founder John Bogle introduced the Vanguard 500 Index fund with his concept of passive, low-fee index fund investing.
- 1990s—During this decade, mutual funds became the number one choice for retirement savings in 401K and IRA plans.
- In the beginning of the 2000s, mutual funds dominated the investing sphere, holding trillions of assets.
The Launch of Exchange Traded Funds (ETFs)
There was an innovation waiting to happen while mutual funds controlled the investment ecosystem: exchange-traded funds. ETFs are aimed at merging the diversification potential of mutual funds and the flexibility of company stocks.
- 1989 – The Toronto Stock Exchange opened the Toronto 35 Index Participation Units (TIPs), which were the first known precursors of ETFs.
- 1993 – The introduction of SPDR S&P 500 ETF (SPY), through State Street Global Adviser, changed the way we think about investing.
- 2000s— The unprecedented rise of ETFs began in this period due to the opportunity of investing in bonds, commodities, and even foreign markets.
- 2010s—Niche investors were targeted with the introduction of risk-advanced smart-beta and thematic ETFs.
How Mutual Funds and ETFs Changed Investing
The combination of mutual funds and ETFs brought a whole new dimension to investing with the ability to:
- Diversify—Investors could minimize the risk of particular stocks failing by spreading their investment over numerous assets.
- Affordability—A wider range of people were able to invest due to low fees and expense ratios.
- Liquidity—ETFs provided the ability to trade throughout the day instantly, while mutual funds are only settled at the end of the trading day.
- Passive vs. Active Investing—The introduction of index funds and ETFs turned passive investing into the new mainstream and competition for the actively managed funds.
The Future of Mutual Funds and ETFs
Due to high fees and low liquidity, ETFs are becoming more and more popular over mutual funds. The advancing fintech industry with robo-advisors, fractional shares, and crypto ETFs indicates where the industry is heading. Despite these changes, mutual funds are still deeply embedded in long-term retirement savings.
- 2000s—Many investors capitalized on ETFs, which provided them with exposure to asset classes such as bonds, commodities, and foreign markets.
- 2010s—The sharp increases in smart-beta and thematic ETFs serviced a certain subset of the investor population.
How Investing Changed with Mutual Funds and ETFs
The remarkable growth of mutual funds coupled with the introduction of ETFs changed the dynamics of investing by bringing
- Variety—Investors could mitigate risks as they spread it through different assets instead of relying on individual stocks.
- Cost-Effectiveness—A wider audience was now able to invest thanks to lower fees and reduced expense ratios.
- Liquidity—ETFs could be traded in real time, with no need to settle, unlike mutual funds, which are settled at the end of the trading day.
- Reduced Attention Paying—Index funds and ETFs greatly enabled passive investing while integrating competition towards actively managed funds.
Mutual Funds and ETFs in the Coming Years
In the current era, ETFs are gaining popularity, and mutual funds are losing ground because of their higher fees and lower liquidity. This shift in investment approaches is further emphasized by the appearance of robo-advisors, fractional shares, and the introduction of crypto ETFs. It is worth noting, however, that mutual funds are still an integral aspect of long-term retirement savings.
The birth of mutual funds and ETFs marked a turning point in financial history, making investing more accessible and efficient. As technology and innovation continue to reshape the landscape, these investment vehicles will likely remain at the heart of wealth creation for future generations.
