We are only halfway through 2007 and more than 160 new exchange traded funds (ETFs) have entered the market. Over the past couple of years, the ETF industry growth has exploded, so what is an investor to do? Sonya Morris for Morningstar shares the questions and guidelines she uses to help her sift through the bevy of products.

How does it compare to the competition? Or, how does an ETF get your attention? A smart ETF provider will build a better product than what is currently available. Morris argues that Vanguard’s recently launched bond ETFs are an improvement over previously available bond ETFs. They are a bit more diversified and have a lower expense ratio. This shouldn’t be the deciding factor in choosing one ETF over another though. Review all ETFs that are available, and know what you are buying and how it fits with your portfolio and growth strategy. 

Is the timing right? ETFs tend to roll out in sync with the hottest market, and this can be confusing for any investor. Don’t get caught up in the hype, and try to visualize how the ETF will perform if market conditions changed. Look at the holdings in the ETF, and review how are they currently performing and how they performed in a declining market environment. It might be wise to hold off and wait for the ETF to establish a performance track record before diving in. 

Does the benchmark employ a methodology that makes sense? Benchmark construction has a lot to do with evaluating an ETF. The beauty of an index is that you can see its composition. Does the index hold companies that make sense for that index? What kind of exposure are you getting? What about the weighting of the holdings? Take untested indexes with a grain of salt, especially when the factors are more qualitative than quantitative.

Adding ETFs to your portfolio doesn’t have to be difficult. Do some homework, know your tolerance for risk and make goals. Setting stop-losses also can help stomach any declines in the market, sector or region in which you’re invested.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.