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 -- and that savings can add up over the years.

ETFs give active traders the ability to buy and sell shares at any time during the trading day. In contrast, investors can only trade shares of traditional mutual funds 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 it can means hundreds or even thousands of dollars in your pocket instead of going to your fund company.

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. Here's a quick rundown:

  • The Total Stock Index combines S&P 500 companies like AT&T (NYSE:T) and Chevron (NYSE:CVX) with smaller stocks.
  • The European Stock Index owns shares of companies like GlaxoSmithKline (NYSE:GSK) and BP (NYSE:BP).
  • The Mid-Cap Value Index holds stocks including Mattel (NYSE:MAT) and Discover Financial (NYSE:DFS).
  • The Small-Cap Growth Index focuses on small up-and-comers like Brocade Communications (NASDAQ:BRCD).
  • The Total Bond Index owns a mix of Treasury, agency, and corporate bonds.

Below is a comparison of costs for certain funds and their ETF counterparts:

Vanguard Fund Name

Expense Ratio For Mutual Fund

Expense Ratio For ETF Expenses

Total Stock Index

0.18%

0.09%

European Stock Index

0.29%

0.18%

Mid-Cap Value Index

0.30%

0.15%

Small-Cap Growth Index

0.28%

0.15%

Total Bond Index

0.22%

0.14%

Source: Vanguard. Mutual fund expenses are for investor class shares.

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%-0.15%, that can add up to a lot of money, especially if you have a large portfolio. For instance, if you invest $10,000 each year, earning 10% annually versus 9.85% over 30 years will put an extra $40,000 in your pocket.

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.

Learn more about the differences between ETFs and mutual funds in this informative article.

This article was originally published on April 25, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned in this article. Discover Financial Services is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy pays off big every time.