How to Tell Which ETFs Are Right for You

Given how popular exchange-traded funds have become, it's no surprise to see fierce competition among the leading ETF providers. Before you decide to jump into the ETF fray, though, you need to ask yourself which provider gives you the things you want most from your ETF investments.

With 2012 in the books, analysts are looking back at the past year to try to find trends that could be useful in projecting the state of the ETF universe in 2013 and beyond. Let's take a look at some of the key issues that dominated ETFs last year in an effort to identify which ETFs might be best for your portfolio.

Show me the money
ETFs constantly fight among their rivals to gather assets. Even for those ETFs that carry rock-bottom annual expenses in the neighborhood of 0.1%, every $1 billion in assets an ETF can pull under its umbrella means an extra $1 million in management fees. Given that it takes very little incremental cost to manage additional assets, the extra fee money they generate ends up being almost pure profit for the fund company.

So for BlackRock (BLK -0.86%), news that its iShares funds attracted an industry-leading $85.3 billion in exchange-traded product assets during 2012 was quite welcome. Despite the fact that the company manages plenty of money beyond the ETF universe, much of the 20% gain for BlackRock's shares over the past year likely came from the big boost in its assets. Finishing second was Vanguard, which pulled in $54.2 billion.

Yet both companies made steps toward cutting back on costs in ways that were favorable to investors overall. For Vanguard, even minor cuts helped give the company a low-cost advantage, even as Schwab and other smaller ETF providers have tried to undercut Vanguard's fees. Perhaps more important was BlackRock's decision to create iShares Core ETFs, featuring lower expenses than its more institutionally focused ETF line.

Among individual funds, State Street (STT 0.32%) captured the top spot with $15.8 billion in additional assets for its SPDR S&P 500 ETF (SPY -0.21%). Meanwhile, Vanguard's Emerging Markets ETF (VWO 0.27%) pulled in $10.6 billion, narrowly beating a similar emerging-markets fund from iShares.

Don't sacrifice quality
The biggest ETF won't necessarily be the best ETF for your portfolio, though. Other factors come into play, including not only expense ratios but also total trading costs and liquidity.

When S&P Capital IQ ran its own proprietary analysis, it put Vanguard at the top of its list in terms of stock ETF quality. Low expenses for its stock funds of just 0.17% on average were a big part of the No. 1 ranking, and combined with solid demand and good index-tracking records, Vanguard locked up the top spot. iShares, State Street, and Invesco's PowerShares finished out the top four.

Forget about loyalty
As with active mutual funds, successful ETF investing requires you to diversify your portfolio across different providers. Just as certain fund managers will be better specialists at a particular type of mutual fund and perform much worse in dealing with other types of assets, so too do some ETF providers have specialties. Vanguard, for instance, doesn't have any actively managed ETFs, while Pimco's Total Return ETF (BOND -0.25%) has taken the bond ETF market by storm with its outperformance and innovative strategies. State Street's sector ETFs were innovators in the industry, while iShares and its single-country ETFs opened the world to U.S. investors.

In the end, what's most important isn't any single ETF in your portfolio but rather how they fit together into a cohesive whole. Using the mix-and-match approach to cherry-pick the best ETFs from all of the available providers out there, you'll get the most out of your ETF portfolio if you keep your mind open to alternatives regardless of which company offers them.