Step I: Find a brokerage that offers a wide selection of ETFs
You can buy ETFs almost anywhere you can buy a stock – they can be purchased through a broker or a brokerage account. Your best bet is through an online brokerage (like E*Trade, Charles Schwab or Fidelity) with low commissions. Read more about how to find the best brokerage in our investment brokerage guide.

Before you commit to a brokerage firm, however, make sure they offer everything you’re looking for. Some smaller outfits may only offer an edited selection of ETFs – though they should offer the most widely-used and easy to trade ones.

Step II: Choose a high-quality ETF that fits into your investment plan
You want to evaluate ETFs the same way you would any other mutual fund.

You should try and answer the following questions: What does the index track, how is it constructed, what’s inside and how long has it been around?

While ETFs that track long-standing indexes such as the S&P 500 and Russell 3000 have stood the test of time, many ETF creators are stretching the definition of indexing.
Meanwhile, some have cooked up new indexes that track arcane segments of the market. As a long-term investor, you want to avoid newfangled ETFs that track esoteric benchmarks.

Read our Grilling Guide for advice on how to get this information.

Step III: Consider costs
An expense ratio tells you how much an ETF costs. The amount is skimmed from your account and goes towards paying a fund’s total annual expenses. Remember, the expense ratio doesn’t include the brokerage commissions you pay to buy and sell ETF shares.

The average ETF carries an expense ratio of 0.44% (that means it’ll cost you $4.40 in annual fees for every $1,000 you invest), while the average traditional index fund costs 0.74%, according to Morningstar. On the flip side, there’s been a proliferation of more narrowly-focused and exotic ETFs – many of which are not only useless, but much more expensive. Avoid these funds unless you REALLY know what you’re doing.

If you’re thinking about investing in a lifecycle fund that invests in ETFs check to see if it will charge an extra management fee. Lifecycle funds, also known as target-dated retirement funds, invest in a combination of stocks and bonds funds whose mix becomes gradually more conservative as the investor reaches retirement. You might be better off in a target-date fund that invests in regular index funds and doesn’t charge this extra fee. Be sure to do a side-by-side comparison.

Step IV: Consider tax-efficiency
Most ETFs are pretty darn tax-efficient because of the special way they are built. However, some ETFs are mimicking newer indexes that are less static and trade more often. These may trigger more capital gains costs.

Meanwhile, some ETFs invest directly in precious metals, such as gold, are considered “collectibles” and are taxed at a much higher rate. Gains on collectibles are taxed at a maximum rate of 28%, rather than the 15% long-term capital gains rate.

Lastly, don’t forget that trading in and out of ETF shares can generate taxable gains, just like stocks.

One More Step: Know the key players and their nicknames:
Different ETF providers call their ETF wares different things:

• Barclays brands their ETF shares as iShares.

• State Street calls their products SPDRs (pronounced spiders).

• Vanguard just calls theirs Vanguard ETFs (they used to be called Vipers).

Other ETFs are so popular they’ve earned nicknames of their own:

• Spiders: Not to be confused with State Street’s ETF brand, this is the original spider – the first ETF ever – was launched by the same firm in 1993. Officially known as the SPDR S&P 500 ETF (SPY), it tracks the S&P 500 Index.

• Cubes or Q’s: This refers to the widely-traded PowerShares QQQ Trust, which tracks the Nasdaq 100 Index, or the largest 100 non-financial stocks in the Nasdaq Composite Index. The NASDAQ is largely comprised of tech stocks.

• Diamonds: More formally known as the Diamonds Trust Series I (DIA), this ETF tracks the Dow Jones Industrial Average.

Want to Know More?

• What's an ETF?
• Who Should Buy an ETF?
• Grilling Guide: Questions to Ask When Shopping For an ETF