The U.S. mutual fund industry has been steadily shrinking, with the number of U.S.-listed mutual funds falling from over 8,100 in 2018 to 6,768 in 2025. This decline is partly due to the rise of exchange-traded funds (ETFs), which offer lower fees, greater tax efficiency, and intraday liquidity.

Red Flags for Investors

With over 5,500 ETF products available, investors must be cautious when choosing a fund. Some mutual funds and ETFs have structural drawbacks that can lead to poor performance, regardless of the underlying investment thesis. Five key red flags to watch out for include capital gains distributions, excessive fee structures, name and benchmark changes, liquidity dislocations, and fund closures.

Capital gains distributions can result in a tax bill for investors, even if they haven’t sold any shares. This can occur when a fund’s portfolio manager sells appreciated securities, realizing capital gains that are then distributed to shareholders. For example, the Fidelity Growth Discovery Fund reported an annual turnover rate of 78% as of December 2025 and has historically made sizable capital gains distributions.

Excessive fee structures can also eat into investors’ returns. An expense ratio represents the annual cost of owning a fund, expressed as a percentage of its assets. A high expense ratio can be a significant hurdle to long-term performance, especially if two funds provide essentially identical exposure. Investors should be wary of high expense ratios, particularly for passive funds that track a well-known index.

Original reporting: Alexandria, VA News – WTOP News — read the source article.