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An ETF Strategy to Save You Money

By Motley Fool Staff - Updated Apr 5, 2017 at 7:52PM

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Take advantage of lower fund expenses with some index ETFs.

Exchange-traded funds have grown explosively in recent years, in part because of their usefulness for investors who trade frequently. But ETFs can help you save money even if you follow a buy-and-hold strategy.

ETFs give active traders the ability to buy and sell shares at any time during the trading day. In contrast, investors can trade shares of traditional mutual funds only once daily, at the fund's closing price for the day. Also, many mutual funds have recently begun imposing penalty fees for excessive trading, limiting their investors to just a handful of trades every few months. These fees make ETFs the only viable option for active traders.

Saving money on fund expenses
Buy-and-hold investors, on the other hand, don't benefit from most of the ETF features that active traders like. However, ETFs provide a big cost advantage over many mutual funds. While many actively managed stock mutual funds charge upward of 1% for fund expenses annually, you can find many ETFs that charge 0.25% or less in annual expenses. That may not sound like a lot, but on a $75,000 investment, the lower expenses of ETFs will put an extra $560 or more in your pocket.

Of course, if you use index mutual funds, you've already captured a decent chunk of these savings. Yet you may be able to save even more by switching to index ETFs.

For instance, Vanguard, which is known for its low-cost investment options, has a number of index mutual funds and ETFs that follow exactly the same strategy. Below is a comparison of costs for certain funds and their ETF counterparts:

Vanguard Fund Name

Fund Ticker

Fund Expenses

ETF Ticker

ETF Expenses

Annual ETF Savings

Total Stock Index

VTSMX

0.15%

(NYSE:VTI)

0.07%

$60

European Stock Index

VEURX

0.22%

(NYSE:VGK)

0.12%

$75

Mid-Cap Value Index

VMVIX

0.24%

(NYSE:VOE)

0.13%

$83

Small-Cap Growth Index

VISGX

0.22%

(NYSE:VBK)

0.11%

$83

Total Bond Index

VBMFX

0.19%

(NYSE:BND)

0.11%

$60

Source: Vanguard. Savings assumes $75,000 investment.

From an investing standpoint, these funds own the same stocks. For instance, the Mid-Cap Value ETF owns the same shares of Noble Energy (NYSE:NBL) and Vulcan Materials (NYSE:VMC) that the corresponding index mutual fund does.

Yet as you can see, most of Vanguard's index ETF offerings have even lower expenses than their index mutual funds. While the savings is typically only about 0.1%, that can add up to a lot of money, especially if you have a large portfolio.

Some downsides to ETFs
There are some extra costs you bear to buy ETF shares. You'll pay a brokerage commission each time you buy new ETF shares. So if you're making monthly contributions to your savings, the extra commissions involved in buying ETF shares 12 times a year will probably wipe out any reduced expenses. If you're no longer adding to your portfolio or have new savings earmarked to other funds, however, you'll only have to make a handful of transactions on the front end.

The other drawback to ETFs is that you may not be able to reinvest your dividends as easily as with mutual funds. Without free reinvestment, you'll either have to incur brokerage fees to buy new shares with your dividend payouts or give up on reinvesting. Mutual funds, on the other hand, make it easy to reinvest dividends and capital gains distributions.

If you're looking to reduce your investing expenses, ETFs are definitely worth a closer look. Even if you never plan to take advantage of their trading flexibility, ETFs can leave you with more money in your portfolio.

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This article, written by Dan Caplinger, was originally published on April 25, 2007. It has been updated. Dan doesn't own shares of the companies mentioned in this article. Vulcan Materials is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy keeps you warm at night.

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Stocks Mentioned

Noble Corporation plc Stock Quote
Noble Corporation plc
NEBLQ
Vulcan Materials Company Stock Quote
Vulcan Materials Company
VMC
$178.23 (1.49%) $2.62

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