The U.S. mutual fund industry has been steadily shrinking. Since 2018, the number of U.S.-listed mutual funds has fallen from…
The U.S. mutual fund industry has been steadily shrinking. Since 2018, the number of U.S.-listed mutual funds has fallen from more than 8,101 to 6,768 in 2025. Part of that decline reflects the proliferation of exchange-traded funds, or ETFs, which can offer lower fees, greater tax efficiency and intraday liquidity.
In some cases, asset managers have outright converted existing mutual funds into ETFs. That migration could accelerate following regulatory approval allowing multiple asset managers to offer ETF share classes of existing mutual funds. The ETF universe itself has grown to more than 5,500 products.
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With that much choice, “buyer beware” has never been more applicable. The industry now extends well beyond conventional stock and bond index funds, with increasingly complex products using options, swaps and other derivatives alongside specialized exposures such as collateralized loan obligations and emerging market debt.
One particularly fast-growing category is single-stock ETFs. These products concentrate on a single company and frequently target leveraged or inverse daily returns, making many of them short-term trading vehicles rather than conventional buy-and-hold investments. According to an April 2026 ETF.com report, more than 400 single-stock ETFs were already trading in the U.S. by mid-2026.
More choice does not necessarily mean every fund is worth owning. Some mutual funds and ETFs carry structural drawbacks that have little to do with whether their underlying investment thesis ultimately proves correct. High costs, poor liquidity and other characteristics can produce subpar or unexpected outcomes, even when the underlying assets themselves perform reasonably well.
Here are five mutual fund and ETF red flags investors should watch for:
— Capital gains distributions.
— Excessive fee structures.
— Name and benchmark changes.
— Liquidity dislocations.
— Fund closures.
Capital Gains Distributions
Receiving a year-end capital gains tax bill despite never selling a share yourself has been a rite of passage for many unsuspecting mutual fund investors. The problem stems partly from the open-ended mutual fund structure and the fact that regulated investment companies generally pass realized gains through to shareholders rather than paying the associated taxes at the fund level.
One way this happens is through portfolio turnover. An active manager who frequently sells appreciated securities realizes capital gains that eventually need to be distributed to shareholders. For example, the Fidelity Growth Discovery Fund (ticker: FDSVX) reported an annual turnover rate of 78% as of December 2025 and has historically made sizable capital gains distributions. On Aug. 9, 2024, it distributed $5.71 per share in capital gains at a reinvestment price of $57.67.
“While this is not a new concept, a fund with stellar historical performance and subsequent underperformance is typically a victim of high embedded capital gains,” says Mark Andraos, partner and wealth advisor at Regency Wealth Management.
Redemptions can create another source of realized gains. When mutual fund shareholders collectively withdraw substantial amounts of money, the portfolio manager needs to raise cash by selling securities. Managers can use existing cash, but sustained outflows can eventually force sales of appreciated holdings. Remaining shareholders may then receive a taxable capital gains distribution.
“Strong historical performance plus significant recent outflows is usually a recipe for a hefty tax liability,” Andraos explains. “If you buy into a mutual fund that fits this profile, you’re potentially paying taxes tomorrow for someone’s gains yesterday.”
ETFs largely sidestep this problem through their in-kind creation and redemption mechanism. Rather than requiring the portfolio manager to sell securities to meet every investor redemption, authorized participants can exchange large blocks of ETF shares for baskets of the underlying securities.
However, that tax advantage is a general principle, not a guarantee. ETFs can still make capital gains distributions, particularly when derivatives are settled or the portfolio holds assets that cannot readily be transferred through in-kind redemptions. Investors ultimately need to check Form 1099-DIV to determine whether an ETF distributed taxable capital gains during the year.
Excessive Fee Structures
An expense ratio is the annual cost of owning a fund, expressed as a percentage of its assets. It includes the management fee paid to the fund company, along with administrative, operational, marketing and distribution expenses. An easy way to interpret it is in dollars: A 0.5% expense ratio represents $50 in annual fee drag for every $10,000 invested, assuming the balance remains unchanged.
Investors do not receive a bill for this amount. Expenses accrue incrementally behind the scenes and are reflected in the fund’s net asset value, or NAV, reducing returns over time. Just as investment returns compound positively, fees compound negatively. If two funds provide essentially identical exposure, paying substantially more for one creates an unnecessary hurdle to long-term performance.
Mutual funds have historically made this comparison more complicated through multiple share classes. Different classes were designed for different distribution channels and investor types, with varying minimum investments, sales arrangements and ongoing expenses. Without checking the specific share class, investors could end up paying considerably more for essentially the same portfolio exposure.
“A big red flag for me is a high expense ratio, especially if it’s a passive fund,” says Anessa Custovic, chief investment officer at Cardinal Retirement Planning. “If you have a mutual fund that simply tracks the S&P 500 or really any well-known index, they shouldn’t have a high expense ratio.”
Consider the Vanguard 500 Index Fund Admiral Shares (VFIAX), which tracks the S&P 500 for a 0.04% expense ratio. The Rydex S&P 500 Fund Class A (RYSOX) provides similar S&P 500 exposure but carries a much higher 1.61% net expense ratio. From January 2007 through August 2026, VFIAX produced a 691.8% cumulative return versus 486.7% for RYSOX, translating into terminal values of $79,179 and $58,669, respectively, on an initial $10,000 investment.
[Read: 7 Best Fidelity Mutual Funds to Buy and Hold]
Expense ratios are not necessarily the only mutual fund costs to watch. Some share classes charge 12b-1 fees, which are ongoing expenses used primarily for marketing, distribution and shareholder servicing rather than portfolio management. Investors should also watch for sales loads, which are effectively commissions charged when purchasing shares, known as front-end loads, or when redeeming them, known as back-end loads. Neither inherently improves the fund’s investment performance.
“Paying a 12b-1 marketing fee on a mutual fund is like buying front-row seats, only to find out the money went toward promoting the next tour instead of improving tonight’s show,” says Michael Ashley Schulman, partner at Cerity Partners. “High costs are one of the few characteristics that consistently predict lower net performance over time.”
Another consideration is whether a low advertised expense ratio reflects a temporary waiver. This occurred when spot Bitcoin ETFs launched in January 2024, with some issuers temporarily waiving portions of their fees, sometimes only until a specified date or until the fund reached a certain amount of assets under management.
Finally, look out for acquired fund fees and expenses, which can arise when a fund invests in other investment vehicles. The VanEck BDC Income ETF (BIZD), for example, charges a 0.4% management fee plus 0.02% in other expenses, but reports another 9.27% in acquired fund fees and expenses associated with its underlying portfolio of business development companies.
Name and Benchmark Changes
Funds are not necessarily static over time. With actively managed funds, investors often watch for style drift, where a portfolio gradually moves away from its original mandate, and succession risk, where a successful manager retires and a replacement fails to produce comparable results. Passive funds can experience their own version of this problem with name and benchmark changes.
Sometimes these changes are relatively innocuous. For example, Morningstar recently acquired the Center for Research in Security Prices (CRSP) from the University of Chicago for $365 million, including the CRSP indexes tracked by several Vanguard funds. As a result, some Vanguard fund names now incorporate Morningstar branding without changing the underlying index methodology.
Outright benchmark changes deserve closer scrutiny because historical performance can become misleading if investors assume today’s methodology generated the entire track record. A good example is the Invesco S&P 500 GARP ETF (SPGP). Despite its higher 0.36% expense ratio, SPGP has managed to match the S&P 500 on a pre-tax basis over the trailing 10 years, a difficult feat.
However, that track record does not entirely belong to today’s strategy. Prior to May 22, 2015, SPGP tracked the RAFI Fundamental Large Cap Growth Index. From May 22, 2015 through June 21, 2019, it instead tracked the Russell Top 200 Pure Growth Index. An investor looking only at SPGP’s present benchmark and name could therefore incorrectly attribute returns generated under earlier methodologies to the strategy the ETF follows today.
Regulators can also force a name change when they believe the existing branding could mislead investors. “The SEC’s beefed-up ‘Names Rule’ (finalized 2023, clarified again in 2025) tells managers that the logo must match what’s inside, precisely because past studies show cosmetic name-changes goose flows without any corresponding improvement in performance,” Schulman explains.
The SPDR SSGA IG Public & Private Credit ETF (PRIV), for example, launched in 2025 under the name SPDR SSGA Apollo IG Public & Private Credit ETF. State Street subsequently removed “Apollo” from the fund’s name after SEC concerns that the branding could imply Apollo Global Management directly sponsored or advised the ETF when its actual role was more limited.
Liquidity Dislocations
With ETFs, the market price can differ from NAV, which represents the per-share value of the securities held by the fund. Under normal conditions, authorized participants help keep the two closely aligned through the in-kind creation and redemption mechanism.
This arbitrage process generally prevents large discrepancies from persisting. Large premiums and discounts are more commonly associated with closed-end funds, where shares cannot be continuously created and redeemed, but ETFs can experience them when markets become stressed.
During the surge in precious metals prices, for example, the iShares Silver Trust (SLV) briefly traded at a steep 8.7% premium to NAV on Dec. 26, 2025. The opposite dynamic occurred during the March 2020 COVID-19 sell-off, when some bond ETFs traded at substantial discounts to their reported NAVs as liquidity deteriorated across credit markets.
In situations like these, investors risk buying an ETF for substantially more than its underlying holdings are worth or selling it for substantially less. Checking a fund’s historical premium and discount data can therefore provide useful context on how reliably its market price has tracked NAV.
Liquidity matters even when markets are functioning normally. Every ETF has a bid price, representing the highest price a buyer is currently willing to pay, and an ask price, representing the lowest price a seller will accept. Investors generally buy at the ask and sell at the bid, with the difference known as the bid-ask spread. Keeping that spread as narrow as possible is ideal.
An ETF’s bid-ask spread is not determined solely by the volume of shares changing hands each day. It also depends heavily on the liquidity of its underlying securities and how easily authorized participants can transact in those assets. An ETF holding large-cap U.S. stocks can therefore maintain a tight spread even with modest trading volume, while a fund holding exotic securities may have a much wider one.
The VanEck Africa Index ETF (AFK) illustrates the latter problem. Many of the African equities it owns trade in less liquid markets, contributing to a wide 0.82% 30-day median bid-ask spread. In practical terms, an investor buying and immediately selling AFK under similar conditions could lose substantial value to the spread alone, even if the underlying portfolio did not move.
“I would be very suspicious of ETFs with high bid-ask spreads,” Custovic says. “This to me signals low liquidity, potentially high transaction costs or even lack of buyers in the market.” A wider spread does not automatically make an ETF unsuitable, particularly when it provides exposure that is difficult to obtain elsewhere. However, it does increase trading friction and makes execution more important.
Fund Closures
ETFs are ultimately products, and asset managers are businesses. Like products in any other industry, some become hits while others flop. For every runaway success such as the Roundhill Memory ETF (DRAM), which became the fastest-growing ETF to reach $25 billion in assets under management (AUM) within months of launching, hundreds of others eventually end up in the ETF graveyard.
ETF sponsors can increase revenue by either raising fees or attracting more assets. The latter is generally preferable because investors have become increasingly fee conscious, contributing to the industry’s long-running trend of fee compression. An ETF that fails to attract sufficient assets may therefore generate too little management-fee revenue to justify its operating costs.
ETF.com showed 195 U.S. ETF closures this year through Aug. 5, 2026, alone. There is no hard cutoff for viability, but $50 million in assets is a commonly used rule of thumb for identifying funds that may not have longevity. “According to FactSet, 38% of ETFs have under $50 million in assets under management, and funds that small are prime candidates for the corporate Thanos-snap known as liquidation,” Schulman says.
However, low AUM alone does not guarantee that an ETF will close. A newly launched ETF with $25 million and strong inflows presents a different risk profile from a five-year-old ETF with the same assets and persistent outflows. Investors should also consider the fund’s recent flows, the financial strength of its sponsor and whether the issuer operates overlapping ETFs that could be consolidated.
The types of funds being closed also provide clues. Many of the 2026 closures tracked by ETF.com involved highly specialized single-stock strategies, including products using derivatives to generate leverage or high distributions. Niche thematic funds and alternative ETFs targeting specialized hedging strategies or narrow corners of the fixed-income market also appeared frequently.
Owning an ETF that closes is more inconvenient than catastrophic. Once a closure is announced, investors are given a window to sell before trading stops. Investors who remain are cashed out when the ETF is liquidated, receiving their proportionate share of assets. Closure does not mean investors lose their principal, but it can force an unwanted sale, create a taxable event and disrupt a portfolio strategy.
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5 Mutual Fund and ETF Red Flags originally appeared on usnews.com
Update 08/12/26: This story was published at an earlier date and has been updated with new information.