A New Way to Find the Right ETF

New rankings highlight funds for long-term investors.

By + More

The meteoric rise of exchange-traded funds (ETFs) is one of the biggest shifts in personal investing in the last decade, and it's easy to understand why. Compared with the old mutual fund standby, take your pick of pluses: These index trackers boast lower costs, greater transparency, more frequent trading, tax efficiency, and simple access to more asset classes.

Their soaring popularity among both investors (net assets in ETFs topped $1 trillion for the first time last year) and fund issuers also means the number and variety of funds has swelled from fewer than a hundred a decade ago to more than 1,300 today.

[See top-rated ETFs by category.]

At the same time, the funds themselves have become increasingly complex, evolving from a handful of relatively simple investments tracking major market indexes like the S&P 500 to a wide variety of highly specialized funds with increasingly complex structures that follow everything from oil to airlines with varying degrees of success.

As choices for investors expand exponentially, so has the need for clear, helpful advice in selecting funds.

The U.S. News Best Fit ETF ranking is designed to help sort through the clutter. Created for the long-term, diversity-minded investor, the ranking is designed to help select the most reliable and transparent funds in a wide variety of asset classes.

Here's how we choose funds that are included in the U.S. News Best Fit ETF ranking: For the sake of stability, we've included only funds with at least a one-year trading history and a minimum of $100 million in assets under management. That means Best Fit funds are only the largest, most liquid ETFs available.

Then, funds are compared to their category peers and sorted by a weighted average of their relative expenses, tracking error, bid/ask ratios, and holdings diversity. (See our full methodology).

[See Are Leveraged ETFs Ever Right for Retail Investors?]

Our rankings are also notable for the type of ETFs they leave out—specifically leveraged and actively managed funds. Leveraged funds are primarily for daily trading, while active management is exactly the sort of strategy most ETF investors are looking to avoid with passively managed index funds. Such exotic funds, which hold just a fraction of total ETF assets, occupy the more untested and sometimes misunderstood corners of the market, so we advise less sophisticated investors to stick with the simplest and most proven names, which currently hold the lion's share of all ETF assets.

Within our universe of Best Fit funds, our rankings focus most heavily on the two factors that mean the most to everyday ETF investors: cost and reliable performance. That's why management fees and tracking error, a measure of how well a fund tracks its underlying index, are the two most highly weighted components of our rating.

[See 20 Funds That Have Weathered Downturns.]

Fees matter most because they're second only to actual fund performance in terms of importance for preserving hard-earned investment cash. The average expense ratio among all ETFs is just 0.52 percent, but many of the largest funds boast even more appealing costs.

We also sorted funds based on some of the "hidden" costs that can plague investors, including high turnover and wide bid/ask spreads. We rewarded funds with more diverse holdings to cut down on the risk of a few troubled holdings dragging down a broad-based fund.

The result is a tool to help investors select funds that are likely to work best as part of their broader asset allocation plan, whether they're looking to add commodities, stocks, or bonds to their portfolio.

Here are the Best ETFs in popular categories:

Schwab Emerging Markets ETF (SCHE) #1 among Best Emerging Markets ETFs

iShares COMEX Gold Trust (IAU) #1 among Best Gold-Oriented ETFs

SPDR Dow Jones REIT ETF (RWR) #1 among Best Real Estate ETFs

iShares Russell Top 200 Index Fund (IWL) #1 among Best Large-Cap ETFs iShares Silver Trust (SLV) #1 among Best Precious Metals ETFs