Last month, we examined how exchange-traded funds (ETF) can be utilized within a Just-the-Basics portfolio to reduce costs and boost long-term returns. Good news: Upgraders can also benefit in much the same way by replacing a few current mutual fund holdings with ETF share classes of the same funds.

ETFs aren't new to Upgrading — several have been included among our fund recommendations in recent years. Their inclusion among our regular monthly recommendations is likely to increase as the number and diversity of ETFs continues to expand, and our comfort level with their track records grows. The recent development of actively-managed funds beginning to roll out ETF share classes is another sign that points to increased ETF use within Upgrading in the future.

But that's not the only application of ETFs within Upgrading. There's another area where ETFs can make an immediate impact — as a substitute for the currently recommended Vanguard bond-index funds.

As we saw last month, the ETF shares of Vanguard's popular index funds are typically less expensive to own than the investor share classes we've been recommending. The ETF shares typically have expense ratios at least 0.10% lower than the investor share classes. Given these ETFs can be purchased for the small cost of a regular stock trade ($7.95 at Fidelity, $8.95 at Schwab), this is an appealing way to save money on the bond portion of an Upgrading portfolio.

As the table below shows, three of the four Vanguard bond funds used in Upgrading have ETF share classes.

As we explained last month in discussing JtB, if you prefer to stick with traditional mutual funds, you can still save money by switching to the Admiral shares of the Vanguard funds in which you invest at least $10,000 ($50,000 in the case of the Vanguard Inflation-Protected fund).

Last month's transition to using ETFs within Just-the-Basics was a bit simpler, because most JtB accounts were already held at Vanguard, making the purchase of the new ETFs free. Most Upgrading accounts are not held at Vanguard. So the question arises: Does it make sense to pay to switch to these ETFs if you already own the regular Vanguard bond funds?

The answer is fairly straightforward. The investor classes of both Vanguard's short- and intermediate-term bond index funds carry a 0.22% expense ratio. The equivalent ETF shares of these funds cost just 0.11% per year — a savings of 0.11% each year. If your account is with Fidelity or Schwab, no fee should be charged when you sell your current bond funds (these fees are only charged on purchases at these two brokers; other brokers have different policies — see SMI's 2012 Broker Review: Choosing the Broker That's Right for You).

It will cost you less than $10 to buy each new ETF. So you'll pay less than $10 once to make the change. If you have $10,000 invested in one of these bond funds and switch to the ETF, you'll then save $11 each year thereafter from the lower expenses. The more you have invested in each bond fund, the more you'll save.

As we pointed out last month, we noted that Fidelity and Schwab have "house brand" ETFs that are roughly comparable to the Vanguard funds used in JtB. Somewhat surprisingly, this is not the case for Upgraders. Schwab's bond ETFs are too new for us to be confident in recommending them yet. Fidelity's relationship with iShares offers a number of bond ETFs to choose from, but none that line up particularly well with the specific Vanguard ETFs we use. Given the low cost of buying the Vanguard ETFs, we recommend sticking with them even if your account is at Fidelity or Schwab.

The one exception to this, ironically, is in the one bond slot where Vanguard has no ETF share class available — their inflation-protected fund (VAIPX). Here, the iShares Barclays TIPS Bond ETF (symbol: TIP) compares quite well to VAIPX over the past 3- and 5-year periods. Schwab's equivalent ETF (symbol: SCHP) is relatively new, but has comparable returns over the past year or so. Vanguard's inflation-protected fund is also the one fund for which Vanguard requires a $50,000 investment (rather than $10,000) to move up to the cheaper Admiral shares. So TIP or SCHP seem like attractive alternatives in that slot.

Vanguard's bond index funds have long been top performers in their respective categories, which is why we selected them for the bond portion of our Upgrading accounts in the first place. Purchasing the ETF shares can save you money on the initial purchase (at most brokers, the stock trade commission will be significantly cheaper than a transaction-fee fund purchase), while also costing less on an ongoing basis due to their lower expense ratios. That's a win-win Upgraders should appreciate!