The ETF craze just crossed a huge hurdle

Mom-and-pop investors have crossed an important threshold in how they're putting their money to work.

Over the past 12 months, the group, through registered investment advisors, brokerages and other retail sources, has put more money into exchange-traded funds than mutual funds, according to Broadridge Financial Solutions, an investor communications firm. That has not happened before.

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While there's still a huge mismatch in terms of total money under management between the two industries—$2.1 trillion for ETFs, $13.5 trillion in long-term mutual funds, according to the Investment Company Institute—the trend is worth noting for several reasons.

Conventional wisdom had long held that ETFs were more the playground of traders who use the index-tracking funds in part as hedging tools because they are compiled like mutual funds but can be traded like stocks. Mutual funds, conversely, were seen as long-term investments because they are less liquid.

Traders work on the floor at the New York Stock Exchange.
Getty Images
Traders work on the floor at the New York Stock Exchange.

Broadridge's data, then, represent a significant paradigm shift.

The past year saw $267 billion in ETF assets sold through independent and wirehouse broker dealers, registered investment advisors and discount brokerage firms. That compared with $255 billion in mutual funds, which still saw total assets grow 10 percent though that gain was led more by institutional than retail investors, according to Broadridge.

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"ETFs have become a bigger part of the pie and reasonably adopted by individuals as well as advisers," said Frank Polefrone, senior vice president at Broadridge. "A few years ago there were probably more questions about ETFs and that seems to have gone by the wayside,"

Indeed, despite their liquidity, lower cost and tax advantages, ETFs still have critics.

Prominent among them has been Vanguard founder Jack Bogle, who is perhaps the financial world's strongest supporter of index funds—the leader of the "Bogleheads"—but not a backer of ETFs, even though most of them track broad market measures like the S&P 500 and are similarly passive in nature. (Only 15 percent or so of mutual funds are passive.)

However, since Bogle relinquished his formal duties as head of the company, Vanguard has become a leader in the ETF industry. Vanguard currently ranks second among all providers, with $470.4 billion of its total $3.1 trillion under management dedicated to ETFs, according to ETF.com.

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"Just because you can trade them in the middle of the day doesn't mean you have to trade them in the middle of the day," said Jim Rowley, senior investment analyst at Vanguard. "They're actually funds—pooled investments that buy portfolios to give investors diversified portfolios for securities at reasonably lower costs and can be used in a buy-and-hold manner."

Rowley called the preference for ETFs "a very positive thing for Vanguard."

Still, the big investment advisory firms are reluctant to play favorites, despite the sharper growth rate for ETFs. Mutual funds still generate the bigger fees, though retail investors have begun to recoil against their costs and are demanding more ETFs.

Charles Schwab, which is the seventh-largest provider in the ETF space with $32.4 billion under management, has gotten considerably more aggressive with its offerings.

"We firmly believe that mutual funds and ETFs will continue to play an important and prominent role in investors' portfolios," a Schwab spokesman said in a statement to CNBC.com. "They both provide tremendous benefits as part of a diversified portfolio."