-- If you're new to investing, ETFs can offer a quick, cost-effective way to diversify. And if you're ready to invest a large amount, the commissions will be trivial as a percentage of your investment. (But investors who make frequent smaller investments will probably find index funds a cheaper solution.)
-- Because of their tax-efficiency, ETFs are particularly well suited to taxable accounts.
-- If you're an active or sophisticated trader, ETFs offer more flexible ways to execute portfolio strategies. Because they are traded like stocks, you can execute stop orders, limit orders, short sells and options on ETFs. Just be sure to think about commission costs.
WHEN ETF TRANSACTIONS DON'T MAKE SENSE
-- A smaller investor. For example, someone who wants to invest a few hundred dollars a month to begin building a portfolio may be better off with a mutual fund. Even a discount brokerage commission on a small ETF transaction could be disproportionately expensive.
-- If your goal is to outperform the market, an indexed approach, whether through an ETF or a traditional index fund, doesn't make sense. You'll want to consider actively managed funds.
WHAT TO WATCH OUT FOR
As I mentioned, ETFs tend to be diversified, but don't assume that all ETFs are safe. Among the hundreds of ETFs available today are niche products that focus on very narrow sectors, exotic ETFs that invest in esoteric strategies and instruments, leveraged ETFs that, as their name implies, are far more volatile than basic ETFs, and even "inverse ETFs" designed for contrarian investors. These may be good instruments for sophisticated investors, but they are not suitable for most buy-and-hold investors.
There is no question that ETFs represent a very useful instrument for a wide spectrum of investors. But as with any investment, be sure you know what you're buying and at what cost. With ETFs (ditto for any index fund), understand how the underlying index fits into your portfolio. Good luck!