The exchange traded fund industry gathered about $105 billion in new inflows over the first half of 2012, proof of the industry’s growth. Investors that are ready to add ETFs to their portfolios may find that picking one or a few out of the 1,476 trading seems more difficult than ever.

“While ETFs appear quite simple on the surface, these securities can be quite complex. In order to get the most out of ETFs, there’s a lot that investors need to know about the structure, opportunities, and limitations of these securities,” Michael Johnston for ETF Database wrote in a recent article.[ETF Liquidity: What You Should Know]

There are important factors that should be considered before investing in an ETF. Dan Caplinger for The Motley Fool reports that first and foremost, the cost is the most important feature. ETFs are known for being affordable in comparison with mutual funds, but this is not true of every fund. Since expense eats into the principle, this is the deciding factor that should be considered. [Tracking Error: A Hidden ETF Fee?]

Caplinger also says that noticing subtle differences is helpful. The name of two funds can be very similar, so noticing subtleties of funds such as holdings and allocation to sectors are key. Index methodologies are another trait that can effect performance, and is there is consistent rebalancing, cost can be altered.

A track record of at least 3 years is another indicator of how well the fund does what it intends. Tracking error and overall performance in varied markets is key to understanding when certain funds are slated to perform more efficiently. [How to Measure an ETF’s Yield]

Besides researching performance and expenses, know what stocks the fund holds. This can help investors avoid over exposure to a certain sector or stock and also gives them more understanding of what they are investing in.

Tisha Guerrero contributed to this article. 


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.