There are many superlatives we could use to describe the growth in ETFs, but well let the facts speak for themselves. Our first ETF guide, published in 2003, listed 130 exchange-traded funds. This years print guide includes 427 funds, and information on more than 850 additional funds is available on AAII.com.

A more important statistic is the dollar amount of assets held by exchange-traded funds. Investors, both institutional and individual, show their favoritism for an investment by putting their dollars into it. As of the end of June 2011, the ETF universe held $960 billion in net assets, according to research firm Lipper. This represents more than a 100-fold increase since June 1998, when assets totaled just $9.2 billion.

While statistics can look large when calculated from a small base, the industry is continuing to grow at a very strong pace. Since 2007, total assets have more than doubledincreasing by nearly $500 billion dollars. The anticipated introduction of new, actively managed ETFs seems likely to propel these numbers even higher.

This rapid growth has lowered the barriers and costs to many investments. This is particularly the case for foreign markets, currencies, commodities and hedge fundlike strategies. The advantage is that diversification has become easier and cheaper. The disadvantage is that specialized funds have unique risks that may be more difficult to identify before they adversely impact performance. A key rule to consider when evaluating a specialty fund is that just because you can invest in something, does not mean you should.

Another change in the industry is commission-free ETFs. Discount brokerage firmsincluding Fidelity, TD Ameritrade, Charles Schwab and Scottradeallow clients to buy and sell select ETFs without paying commissions. Though there is a transaction cost advantage, the savings should be weighed against the potential performance, diversification and annual expense advantages of a fund that is not commission-free. Put another way, on a $10,000 investment, the waiver of $20 in commissions equates to a one-time savings of just 0.2%. While we welcome lower costs, we dont view the existence or waiver of a commission as something that should be a significant factor when evaluating a fund.

The overwhelming majority of ETFs track an index, such as the S&P 500. However, in many cases an index has

specifically been designed for an ETF to track. This has become particularly evident over the past few years as fund providers seek to differentiate their offerings. The risk is that two similar-sounding funds can have different performance characteristics. This is why it is critical that you understand not only what index the fund follows, but also how its performance may differ from a more widely known index.

Some ETFs use an enhanced-index strategy. These funds follow a specific type of strategy, such as seeking low valuations or other fundamental criteria. Technically, they are passive funds because they track an index. The index itself, however, is based on a strategy that was designed to take advantage of a market anomaly or historical data that favors a certain style of investing. This makes enhanced-index ETFs close cousins of actively managed ETFs. We have designated such ETFs in this guide with an E to the left of the fund name.