There’s a natural progression in the way the public responds to innovation. Something that first seems like a mere novelty becomes an interesting new niche, then a great idea and then, How did we ever get along without this?

In the last five years, the public’s affinity for ETFs raised assets under ETF management by 152 percent, to $2 trillion, up from $793 billion. Mutual fund assets only rose 53 percent during the same period.

By passively and systematically tracking an index, ETFs are far cheaper to run than most actively managed mutual funds that employ portfolio managers and analysts to select securities. That research costs money, and so does the frequent trading that’s common in such funds—they call it active management for a reason—not to mention the buying and selling of fund shares themselves, transactions that always involve the fund provider.

More transparent

ETFs also feature greater transparency. Their underlying portfolios change more rarely because the indexes that they’re based on generally maintain stable lists of components. The high turnover of many mutual funds and the fact that their holdings are reported only four times a year can make it difficult for shareholders to know exactly what they’re holding.

It’s not just the specific securities that can keep mutual fund investors in the dark. The broad nature of the fund itself can become obscured by what’s called style drift. Say growth is outperforming value; the managers of value funds, consciously or not, may start tilting toward more growth-oriented stocks.

Depending on what else they own, shareholders may become overweight in growth stocks and not even know it. By contrast, a value-stock ETF will hold value stocks no matter what.

ETFs are more transparent in another sense. The very low expenses and commoditized nature of ETFs make commissions and kickbacks to brokers or retirement-plan sponsors impractical. So if an ETF is recommended by an advisor or made available by a broker or retirement-plan sponsor, it’s likely to be an unbiased recommendation.

Tax efficiency

ETFs provide investors the opportunity to be far more tax-efficient than mutual funds in several ways.

Both ETFs and mutual funds must distribute any net capital gains incurred inside the fund on an annual basis. However, two factors favor ETFs on this point, causing them to distribute far less on average. The first is a function of the tax efficiency of passive investing, generally. Index-tracking ETFs simply have less internal buy-and-sell churn, as opposed to active mutual funds. Less selling means fewer realized capital gains.

The second factor is more technical and disadvantages even a passive index-tracking mutual fund. If mutual fund investors want to redeem shares, they must do so directly through the fund, which has to sell internal holdings to finance the redemption. Any gains realized in these sales must be distributed pro rata to all investors, not just the ones redeeming their shares.

So you may owe taxes even if you haven’t sold any shares that year. On the other hand, the way you liquidate an ETF position is by selling it on the open market, without affecting other shareholders. With an ETF, another shareholder’s sale will never realize taxable gains for you.