Mutual funds. theyve been the mainstay for retail investors for decades. But will they stay that way? There are lots of options now such as exchange-traded funds (ETFs) and even hedge funds for the exceptionally wealthy.

The reality is that mutual funds will probably be around for some time, and will likely remain the primary vehicle for most investors for a long time to come. The numbers bear this out: According to the Investment Company Institute. some $15 trillion was invested in mutual funds in 2013. The next biggest piece of investors money went to ETFs, at $1.7 trillion. Unit investment trusts and closed-end funds were $87 billion and $279 billion, respectively.

Robust Growth

This doesnt mean that mutual funds will be the biggest thing forever. There are several trends that fund industry executives should probably think about. First of all, while ETFs are still a small share of the market, at least in terms of investor dollars, theyve grown briskly since they were introduced in the early 1990s. In 1995 there was just $1 billion in ETF assets out of a $3 trillion investment company pie; mutual funds held $2.8 trillion of that and the rest was in closed-end funds and UITs. Now ETFs are just over 11% of the business and still growing, but ETFs are a bit like Apple Computers: while their influence has been felt, the actual number of users remains relatively small.

However, that growth rate has been accelerating, and its not clear it will stop, so at some point its possible ETFs might overtake mutual funds. But it will be a long time – if the assets in ETFs grew by 10% per year for 25 years they would only then equal current mutual fund asset levels.

Fees Could Normalize Over Time

And its not clear they will, necessarily. While ETFs offer features that funds dont – for the most part they are cheaper with average expense ratios at 0.44%, whereas index funds are about 0.61% for bond funds and 0.74% for equity funds (the high end). While that sounds like it makes ETFs winners hands down, ETFs, because they trade like stocks, can be hit with brokerage fees for each trade. On top of that, the trend for mutual fund expense ratios is to drop. All three major categories of funds – equity, bond and hybrid – used to carry average expense ratios of about 1%.

Several factors are driving the downward pressure on expense ratios. Some of it comes from the move on the part of investors towards index funds and bond funds – more assets are cheaper to manage because of economies of scale. Competition from ETFs has also played a role, as does the move away from share classes that carry loads – i.e. fees for buying in.

This brings us to who invests in mutual funds. One of the biggest issues the industry has to contend with is getting more people into the field. In one sense thats been a success. When ERISA was passed in the 1970s few people owned stocks at all. By 1980 ownership of any kind of mutual fund was still at only 4.6% of households. Now its 46%. The median income tends to be relatively high – $80,000 per year, solidly in the top third or quartile of Americans.

Most of those assets are being saved for retirement, and the biggest owners of funds are Baby Boomers. with a plurality of 45%. Their kids (Gen-Xers) make up another 25%. That makes sense in that the people who are either saving or have saved for retirement did so during their prime earning years.

What They Buy

Aging Baby Boomers and the need for income security has driven a shift to bond funds. Stock market returns are generally positive, but thats over relatively long periods of time, on the scale of a decade. The financial crisis also hit equity investors hard, and it took a year for the S&P 500. DJIA and Nasdaq to reach their pre-crisis levels, and the S&P and Dow Jones Average didnt reach 2007 levels until the end of 2012. The Nasdaq fared slightly better, hitting its 2007 levels a year sooner. Historical returns dont do anyone who turns 65 during a crisis any good; they arent in a position to wait. (For more, see: Why Todays Recession Tops the Great Depression .)

That means its likely that mutual funds will have to start thinking about security more than they have historically, at least in terms of how such funds are marketed.

Increasingly Niche

Its a countervailing force to the proliferation of funds and ETFs that seem to invest in ever more niche parts of the market. Theres a fund or ETF for nearly every kind of investment – single-country funds, commodity funds, and industry funds, and many other combinations of fixed-income and equity. There are target-date funds and lifestyle funds .

But Index Funds Still Reign

Yet even though millions of people are invested in funds, and presented with a plethora of choices, the average number of funds people own is three, and most of that is in index funds – index funds held 18.4% of the entire pool of mutual fund assets in 2013.

What about individual stocks? While online brokerages are good at funny advertisements, most people dont own individual stocks – the bulk of ownership is via mutual funds or ETFs. Its not hard to see why: to trade one needs money to do it, and people who feel insecure about employment arent going to take that kind of risk. Add in the trading costs for transactions below the thousands of dollars and it doesnt appear that millions of Americans will abandon the fund industry any time soon.

Mutual funds. theyve been the mainstay for retail investors for decades. But will they stay that way? There are lots of options now such as exchange-traded funds (ETFs) and even hedge funds for the exceptionally wealthy.

The reality is that mutual funds will probably be around for some time, and will likely remain the primary vehicle for most investors for a long time to come. The numbers bear this out: According to the Investment Company Institute. some $15 trillion was invested in mutual funds in 2013. The next biggest piece of investors money went to ETFs, at $1.7 trillion. Unit investment trusts and closed-end funds were $87 billion and $279 billion, respectively.

Robust Growth

This doesnt mean that mutual funds will be the biggest thing forever. There are several trends that fund industry executives should probably think about. First of all, while ETFs are still a small share of the market, at least in terms of investor dollars, theyve grown briskly since they were introduced in the early 1990s. In 1995 there was just $1 billion in ETF assets out of a $3 trillion investment company pie; mutual funds held $2.8 trillion of that and the rest was in closed-end funds and UITs. Now ETFs are just over 11% of the business and still growing, but ETFs are a bit like Apple Computers: while their influence has been felt, the actual number of users remains relatively small. (For related reading, see: The Key to Apples Scale? Half a Billion iPhones .)

However, that growth rate has been accelerating, and its not clear it will stop, so at some point its possible ETFs might overtake mutual funds. But it will be a long time – if the assets in ETFs grew by 10% per year for 25 years they would only then equal current mutual fund asset levels.

Fees Could Normalize Over Time

And its not clear they will, necessarily. While ETFs offer features that funds dont – for the most part they are cheaper with average expense ratios at 0.44%, whereas index funds are about 0.61% for bond funds and 0.74% for equity funds (the high end). While that sounds like it makes ETFs winners hands down, ETFs, because they trade like stocks, can be hit with brokerage fees for each trade. On top of that, the trend for mutual fund expense ratios is to drop. All three major categories of funds – equity, bond and hybrid – used to carry average expense ratios of about 1%.

Several factors are driving the downward pressure on expense ratios. Some of it comes from the move on the part of investors towards index funds and bond funds – more assets are cheaper to manage because of economies of scale. Competition from ETFs has also played a role, as does the move away from share classes that carry loads – i.e. fees for buying in.

This brings us to who invests in mutual funds. One of the biggest issues the industry has to contend with is getting more people into the field. In one sense thats been a success. When ERISA was passed in the 1970s few people owned stocks at all. By 1980 ownership of any kind of mutual fund was still at only 4.6% of households. Now its 46%. The median income tends to be relatively high – $80,000 per year, solidly in the top third or quartile of Americans.

Most of those assets are being saved for retirement, and the biggest owners of funds are Baby Boomers. with a plurality of 45%. Their kids (Gen-Xers) make up another 25%. That makes sense in that the people who are either saving or have saved for retirement did so during their prime earning years.

What They Buy

Aging Baby Boomers and the need for income security has driven a shift to bond funds. Stock market returns are generally positive, but thats over relatively long periods of time, on the scale of a decade. The financial crisis also hit equity investors hard, and it took a year for the S&P 500. DJIA and Nasdaq to reach their pre-crisis levels, and the S&P and Dow Jones Average didnt reach 2007 levels until the end of 2012. The Nasdaq fared slightly better, hitting its 2007 levels a year sooner. Historical returns dont do anyone who turns 65 during a crisis any good; they arent in a position to wait.

That means its likely that mutual funds will have to start thinking about security more than they have historically, at least in terms of how such funds are marketed.

Increasingly Niche

Its a countervailing force to the proliferation of funds and ETFs that seem to invest in ever more niche parts of the market. Theres a fund or ETF for nearly every kind of investment – single-country funds, commodity funds, and industry funds, and many other combinations of fixed-income and equity. There are target-date funds and lifestyle funds .

But Index Funds Still Reign

Yet even though millions of people are invested in funds, and presented with a plethora of choices, the average number of funds people own is three, and most of that is in index funds – index funds held 18.4% of the entire pool of mutual fund assets in 2013.

What about individual stocks? While online brokerages are good at funny advertisements, most people dont own individual stocks – the bulk of ownership is via mutual funds or ETFs. Its not hard to see why: to trade one needs money to do it, and people who feel insecure about employment arent going to take that kind of risk. Add in the trading costs for transactions below the thousands of dollars and it doesnt appear that millions of Americans will abandon the fund industry any time soon.

Back to the Future?  

Jack Bogle. the legendary former head and founder of Vanguard Group. has often noted that when he started in the business mutual funds were designed to follow large groups of blue-chip stocks – essentially they were index funds. That changed as more people got access to them – largely via retirement accounts – and the stock market boomed in the 1960s. The mantra then became to beat the market. Perhaps the most famous fund to do that was Fidelitys Magellan fund, which was doing just that until 1990. The fund faltered after that, and since 2006 its been underperforming the S&P. (For more, see: The Lowdown on Index Funds .)

Bogle has told several outlets, such as National Public Radio, that he doesnt think funds can achieve the kinds of numbers that beat the market – which would mean annualized rates of about 9% – without undue risk to fund shareholders. That, he says, is going to be challenge because so many people are using mutual funds to save for their retirement. (For more, see: ETFs vs. Index Funds: Quantifying the Differences .)

Its possible that funds can do it; it is certainly possible that the economy will grow by leaps and bounds in the next couple of decades. Its also possible that the fund industry might have to actually change radically, paring back the exotic investment flavors in favor of an old-school approach like that advocated by Bogle.

Then theres investor psychology. Plenty of people left the stock markets entirely in the wake of the great recession, some permanently. The people who experienced the Great Depression first hand were not enthusiastic stock investors. It may be that the Great Recession has produced a similar result, if less stark – if for no other reason than that saving for retirement is mandatory in the absence of defined benefit plans. So lots of money will flow into index funds and bond funds, but the more exotic types will need a harder sell.

The Bottom Line

The mutual fund industry is probably here to stay, and while the traditional mutual funds dominance is eroding, it will be a long while before they are no longer the mainstay of most peoples savings plans.

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