A Suze Orman exclusive

A Few Small Basis Points = Big Money
The average annual fee for an ETF can be as low as 10 basis points or so; in plain English, that's 0.10 percent, or one-tenth of one percent. That compares to many actively-managed mutual funds with annual expense ratios (the annual fee to cover the managerial and administrative costs) of 1.5 percent. And what can be really irksome is that often you're paying 1.5 percent or more on a mutual fund, but the fund essentially behaves like an index fund. That's what's known as a "closet" index fund. Check your fund's long-term performance: if it looks and smells a lot like its benchmark index, I don't know why you're bothering paying those high expenses when you could get an ETF much cheaper. Now maybe you're thinking, "Suze, why the heck are you wasting my time talking about the difference between a measly 0.10 percent and a piddly 1.5 percent?" Well, stick with me for a few seconds and you'll be thanking me for sweating the small details.

Let's assume you have $10,000 you plan to invest for 30 years, and that it will grow at a fairly conservative annualized rate of 8 percent. Now let's give you two options: the SPDR that tracks the S&P 500 (and has a 0.12 annual expense charge) or a basic managed mutual fund that at the end of the day has performance that pretty much mimics the S&P 500 (and has a 1.5 expense ratio). In 30 years the SPDR investment will be worth $97,066, while the mutual fund investment with the 1.5 percent annual charge is going to be worth $63,944. It's your call, but "saving" more than $30,000 seems smart to me. At the end of the day, investing is all about what you keep, not what you earn before expenses are subtracted from your account.

ETFs are IRS Friendly
Those of you who make investments outside of any retirement accounts are absolutely crazy if you are using actively managed funds rather than ETFs.

Actively managed funds have a whopping tragic flaw. When you buy actively managed fund shares, you literally inherit all the capital gains that fund owns. That means you could invest on Monday, and if on Wednesday the fund made a capital gains distribution, you would be stuck paying the tax on the distribution even though you didn't own the shares long enough to enjoy any of that gain.

With an ETF you have a lot more control over your tax bill. ETFs are designed to not make capital gains distributions - just like an index mutual fund. That means your ETF tax bill is most likely only going to be triggered by you: when you sell, your taxes will be based on your personal gain (or loss). Anyone who has ever spent tax season swearing over their mutual fund 1099 forms will appreciate this tax advantage for ETFs.

The Brokerage Fee Factor
There is, however, one big thing to watch out for with ETFs. Because ETFs essentially trade like a stock, you have to buy and sell shares through a brokerage. Even if you use a discount brokerage that charges $9 or $10 a trade, you're looking at a round-trip of $20 or so. That's not cataclysmic, but let's remember that no-load mutual funds let you buy and sell without any transaction costs.

Because of the trading cost, I wouldn't recommend ETFs for anyone who uses the long-term investment strategy known as Dollar Cost Averaging. This terrific investing approach requires periodic investments - once a month is typical - so if you use an ETF you are going to run up a hefty trading bill.

Funds are a smarter alternative for anyone who Dollar Cost Averages. That's because the brokerage commission on the ETF is going to more than offset any savings from the ETF's slightly lower expense charge, when compared to an index mutual fund.

Let's assume you invest $1,000 in a Roth IRA in both the SPY ETF, which has an annual charge of 0.12 percent, and in the Vanguard 500 Index fund, which has an 0.18 percent expense charge. And we'll assume that after the initial investment you continue to invest $100 a month for just one year. For simplicity's sake, I'm going to assume that you don't see a gain (or loss) in your investment.

With the SPY, your expense charges will be roughly $2.25 over the entire year, but you also will pay a commission on each monthly investment. If we assume your discount brokerage charges $10 a pop, you're looking at $120 in brokerage costs for the year. That brings your ETF cost total to roughly $122. If you did the exact same thing with the Vanguard Index fund - where there is no charge for monthly automatic investments - your total costs are going to be about three bucks. By sticking with the old-fashioned fund you will save nearly $120.

Another way to look at this is to think about how much of your total investment for the year is siphoned off to pay all your fees. The ETF costs come to about 5 percent of your total $2,200 investment for the year. So that means the ETF would need to gain about 5 percent more than the Vanguard Index fund just to pull even on an after-cost basis. But that's not going to happen, my friends, because the ETF and the fund are investing in the same exact index. Their only real difference is in their expenses.

Bottom line: stick with funds if you DCA.

But if you have a lump sum to invest, then ETFs are a great cost-effective option.