It’s Easier Than Ever for Fund Investors to Build a Good Portfolio

A lot has changed for fund investors since Morningstar was founded about 40 years ago. There are more than 10 times as many funds available, household ownership of funds has increased, costs are lower, disclosure is better, and passively managed funds have overtaken active.

Ultimately, though, the best way to assess how well the industry has matured is by looking at the quality of outcomes for investors. Through that lens, the story is still generally positive, but with a few negatives mixed in.

How the Fund Industry Looked Back Then

Investing in mutual funds was far from mainstream four decades ago. About 12% of households owned mutual funds in 1984, based on data from the Investment Company Institute, and funds made up less than 2% of household financial assets. Money market fund assets totaled about $233 billion, but mutual fund assets claimed less than $140 billion in assets.

How would an investor have gone about buying a fund four decades ago? She might start by working with a broker, as load (or commission-based) funds made up a large chunk of the fund universe. Or an investor might start by calling a fund company to request a prospectus and then mailing in a check to fund an account. Investors often had no way to tell who was actually managing the fund or how close closely it would follow its stated investment objective.

There were about 900 funds available, with assets mostly concentrated in government-bond funds, large-cap stock funds, and hybrid funds. Only a handful of index funds existed, making up a small sliver of the fund universe. For equity funds, asset-weighted expense ratios averaged about 80 basis points for no-load funds, although total costs were significantly higher for funds that carried additional tolls such as front-end and back-end loads.

How the Fund Industry Looks Now

Investors now have far more choices. Morningstar’s US fund database now includes roughly 10,400 mutual funds and exchange-traded funds (not including multiple share classes), spanning about 130 different investment categories.

Costs are much lower, as well. For equity funds, asset-weighted expense ratios have dropped below 30 basis points. Load funds are much less prevalent than in the past. Lower-cost trends partly reflect the tremendous growth of ETFs, which now account for nearly a third of industry assets after the first ETF was born in 1993. ETFs not only sport lower costs but also allow for intraday trading, better portfolio transparency, and much better tax efficiency compared with open-end funds.

The growth of index funds has been another major trend. Passively managed funds now account for slightly more than half of all fund industry assets. That’s a good thing for investors because active managers have generally failed to add enough value to offset their additional costs. Low-cost, passively managed investment options are now available for nearly every asset class. That means investors can easily assemble a diversified portfolio with a few keyboard clicks.

The quality of management has improved on the active side, as well. Most large actively managed funds have a team of seasoned portfolio managers and analysts supporting them. It’s also much less common to find aggressive portfolio managers who make huge bets on market trends or individual stocks. And across the industry, the mutual fund trading scandal that emerged in 2003 led to significant improvements in ethics and disclosure.

Investors who don’t want to build their own portfolios have much better options, as well. Back in 1984, balanced funds, such as Vanguard Wellington VWELX, were the main option for getting exposure to both stocks and bonds in a single package. Target-date funds, which first came on the scene in 1994, took the balanced-fund concept and made it better. They provide broader asset-class diversification and an asset-allocation mix that automatically adjusts over time. By doing so, they provide a prebuilt portfolio that requires little maintenance or oversight. As of the end of 2023, target-date funds (including those structured as collective investment trusts) claimed more than $3.2 trillion in assets. That means that millions of investors now have access to broadly diversified portfolios in a single package.

The Problem of Choice

Now let’s turn to the negative side. While the industry’s best funds have gotten cheaper and more accessible, there has also been a proliferation of bad, potentially dangerous investment options. The fund industry has always had some of those: think “government guaranteed” funds, option-income offerings, market-timing vehicles, short-term multimarket funds, and gimmicky funds that latch onto whatever market trends are currently in vogue.

Based on raw numbers, the volume of products with little to no investment merit has never been higher. To give just a few examples, Morningstar’s database now includes about 70 funds specializing in digital assets, 50 energy limited-partnership funds, 130 inverse trading funds, 190 leveraged trading funds, and 340 thematic funds. These are speculative vehicles that are more likely to cause harm than build wealth.

Moving in the Right Direction

Fortunately, these offerings play a pretty marginal role. While the industry has continued to roll out some ill-advised products, most fund investors have a better investment experience than they did four decades ago: They pay less, they capture more of their funds’ returns, they transact more easily, and they do so with the benefit of clearer, more comprehensive data and disclosures. Industry assets are more concentrated than ever before in the best and most sensible funds, including index funds and target-date funds.

Of course, there’s still room for improvement over the next 40 years. But on balance, the direction of travel has been a positive one.