ETFs: 5 smart strategies

Exchange-traded funds can cut your investment costs, lower your tax bill and simplify your life. Just make sure you handle them with care.

(MONEY Magazine) - When Exchange-Traded funds, or ETFs, came on the scene in the 1990s, they looked like the rarest of new financial products - one that actually made money for you instead of just your broker.

The earliest ETFs emulated the Standard & Poor's 500 and other broad stock indexes. They were like traditional index funds, only better, offering the same one-stop diversification but with lower fees and tax bills.

As more financial advisers and small investors caught on to ETFs' advantages, the companies that issue them began expanding beyond major indexes to narrower slices of the economy such as health care and technology.

Again, the benefits to you were clear: Avoid the high management fees of sector funds and lower the risk that comes with picking stocks. It's no surprise that investment pros were soon calling ETFs the coolest thing to come along since, well, index funds, and predicting that ETFs would revolutionize the way you invest.

And then things went from cool to, like, crazy.

Not content to limit themselves to major market benchmarks, ETF sellers began churning out dozens of funds aimed at ever smaller market subsectors, including leisure and entertainment, networking and semiconductors.

The number of ETFs has ballooned from just 30 with $34 billion in assets six years ago to more than 200 today holding more than $300 billion. ETFs are quickly becoming a means of turning long-term index fund investing on its head, providing an easy way to make risky investments in whatever slice of the market happened to be hot five minutes ago.

Wanna invest in a nanotechnology or clean-energy ETF? You can -- although it's debatable whether you should. Ditto for that euro ETF you can buy if you believe that the value of the dollar will fall.

That doesn't mean ETFs are now so dangerous that they're only for the foolhardy. You can still cash in on their original promise if you ignore the hype and instead focus on how they might fit into your long-term investing strategy.

With that attitude in mind, here are five smart ways you can make the most of ETFs.

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