How to Build an ETF Portfolio

NEW YORK (TheStreet) -- The ETF industry recently hit a milestone, as assets passed the $1 trillion dollar mark despite uncertain market conditions. The transparency, accessibility and cost efficiency of ETFs have made these products attractive alternatives to index-tracking mutual funds.

When adding ETFs to your portfolio, it is important to be aware how each fund will function as part of your larger investment strategy. The narrowly themed nature of many ETF products can be a double-edged sword. A narrowly themed ETF can help you to target specific regions of the market without stock picking, but it can also lead to increased volatility or over-concentration.

Step 1: Establish a Core

Whether you add ETFs to an existing portfolio or construct a well-rounded portfolio from ETF products, diversification is key. At the core of your portfolio, a broad-based index ETF like the SPDR S&P 500(SPY), Diamonds Trust(DIA) or PowerShares QQQ(QQQQ) helps in providing the foundation for building a complete investment picture.

Step 2: Sector Exposure

Large, liquid sector ETFs allow investors to add emphasis to their investment philosophy. From the Financial Select Sector SPDR ETF(XLF) (XLF) to the iShares Dow Jones US Technology(IYW), heavily traded sector ETFs allow investors to layer on exposure to particular sectors or themes.

As you add sector ETFs to your portfolio, it is important to be mindful of any overlap between your sector holdings and your core positions. Investors starting with the QQQ ETF should be aware of that fund's emphasis on technology. These investors should consider this exposure before adding a sector ETF that magnifies the emphasis of their core holding.