When it comes to diversifying your retirement portfolio and investing in as many companies and industries as possible, nothing beats an exchange-traded fund (ETF). Similar to a mutual fund, ETFs are investments that (attempt to) mirror the return of a particular index. Unlike mutual funds, investors can buy and sell ETFs on the open market like a regular stock.

Both retail and institutional investors like ETFs because they give them the chance to add a basket of equities to their retirement portfolio that they could not otherwise afford to purchase individually. And with more than 1,400 ETFs available, covering every corner of the market (currency, oil, gold, livestock, grain, precious metals, etc.), and more hitting the markets all the time, it can be tough for investors to know where to begin.

But now, it might be getting even tougher.

On August 1, LocalShares launched the Nashville Area ETF (NYSEArca/NASH), the first city-specific ETF. With an initial unit price of $25.00 per share and an annual expense ratio of 0.49%, the Nashville Area ETF invests in a basket of Nashville area publicly traded companies.

But not just any old Nashville company gets included on this ETF. Not only do the companies have to be listed on the major U.S. exchanges, they also have to have their corporate headquarters in the Nashville region, a market capitalization of $100 million, and a daily volume of at least 50,000 shares. (Source: “Nashville Area ETF,” U.S. Securities and Exchange Commission, July 26, 2013.)

The Nashville Area ETF is made up of roughly 25 companies that collectively had more than $94.0 billion in revenue in 2012. Some of the largest holdings in the Nashville Area ETF include: Acadia Healthcare Company, Inc. (NASDAQ/ACHC), Community Health Systems, Inc. (NYSE/CYH), Cracker Barrel Old Country Store, Inc. (NASDAQ/CBRL), Dollar General Corporation (NYSE/DG), Delek US Holdings, Inc. (NYSE/DK), Louisiana-Pacific Corporation (NYSE/LPX), and Noranda Aluminum Holding Corporation (NYSE/NOR).

While ETFs continue to be an attractive alternative for income-starved investors, when it comes to regional or local ETFs, I think caution is in order. Regional pride may motivate some to invest in this kind of ETF, but there are a number of issues to consider.

Not surprisingly, this is not the first time a regional ETF has been tried. The Oklahoma OOK ETF (NYSEArca/OOK) and Texas TXF Large Companies ETF (NYSEArca/TXF) funds debuted in late 2009, but had disappeared less than a year later. In both of these cases, the Oklahoma and Texas ETFs were basically energy ETFs. Therein lies the potential challenges with a regional or local ETF.

Because the Nashville Area ETF is focused on a small geographic region, it could be more susceptible to risk than a broader-based ETF. While its holdings are not heavily concentrated in any one industry, it could be negatively impacted by economic and political conditions or changes in tax policy. A natural disaster—or any other kind of disaster, for that matter—could also hinder business operations in the area.

That said, LocalShares said it plans to look at other potential geographic locations in the U.S.

While adding an ETF to a retirement portfolio can be a great way to increase market exposure, improve diversification, and reduce some element of risk, if the ETF is in too much of a niche, it can also have the reverse affect. When it comes to buying ETFs, it’s best to consider those equities that offer the best overall value.