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NEW YORK (CNNMoney.com) - I keep hearing about exchange-traded funds and wonder if they would make a good addition to my retirement portfolio. What do you think?

-- Gary, Buffalo, New York

Gee, it's hard not to hear about exchange-traded funds, better known as ETFs, these days. Everywhere you turn, some pundit is talking about how great they are or one of the companies that sells ETFs is introducing yet another type of ETF that's supposed to allow you to pull off one amazing investing feat or another.

Want to buy the entire U.S. stock market? There are several ETFs that let you do that. Want to buy the Malaysian or Brazilian or South African markets? No problem. Ditto if you want an index of, say, semiconductor or financial or health care or telecommunication stocks.

With all the hoopla surrounding ETFs, you could easily get the impression that you'll be a wallflower at the dance if you don't get in on the action.

Well, like almost all other investments, ETFs can be very useful tools in a portfolio -- if you're using them for the right purpose. Let me give you the skinny on these investments and then you can decide whether they make sense for you.

Basically, ETFs are pools of stocks, bonds or in a few instances other types of investments that you can trade like stocks. For now, at least, all ETFs are index funds of some sort, which is to say they track a benchmark, unlike actively managed funds whose managers try to beat the market. There's been talk of companies bringing out actively managed ETFs, but so far at least, it's been nothing but talk.

So if ETFs are really nothing more than index funds, why all the excitement?

Well, for one thing, ETFs tend to have very low annual expenses -- much lower than those of actively managed funds and in many (although not all) cases lower fees than similar index funds. One well-known ETF, the Vanguard Total Stock Market VIPER, charges annual expenses of just 0.07 percent. That's more than a full percentage point below what many regular stock mutual funds charge and less than half of what many index funds cost.

ETFs are also highly tax efficient -- that is, they tend to minimize distributions, which drive up your tax bill and drive down your after-tax returns. One reason for this is that they're index funds, and index funds typically trade less than regular mutual funds, which holds down on taxable distributions. But ETFs have another tax advantage. Since they trade like stocks, they don't have to buy and sell shares when new shareholders enter or leave the fund. This too helps cut down on taxable distributions.

Finally, ETFs give investors a greater degree of flexibility. When you buy a regular mutual fund, you buy in at the share price at the end of the day. But ETFs are priced throughout the trading day, just like stocks. So you can buy or sell at whatever the current market price is.

You can also use trading techniques such as putting in stop and limit orders. And if you think the market is heading down, you can even sell an ETF short. (Click here for an explanation of stop and limit orders and here for selling short.)

At this point, you're probably ready to abandon mutual fund holdings and live the rest of your life in the wonderful world of ETFs. Not so fast. No investment is right for all investors, and ETFs are no exception.

First, let's talk cost. Yes, their annual expenses are low, but unlike with regular mutual funds, you must pay a brokerage commission every time you buy or sell an ETF. If you're buying or selling small amounts, those commissions can wipe out the ETF's low-expense advantage.

As for their flexibility, there's no doubt that ETFs give you the ability to move in and out of all sorts of markets to exploit opportunities for gains and provide all sorts of options for a variety of sophisticated trading strategies. I also think there is some doubt about the extent to which individual investors are likely to profit by darting in and out of market sectors and engaging in frequent trading. If anything, I'd say the evidence on this score is that the more trading we do, the lower the returns we earn.

Finally, while the way ETFs were designed certainly enhances their tax efficiency, well, regular index funds aren't exactly slouches in that department. That's also the case for tax-managed mutual funds, which are run specifically to minimize taxable distributions.

Bottom line: I think ETFs can be a good way to put together a well-balanced portfolio that gives you exposure to major asset categories: large and small stocks, growth and value shares, bonds and international stocks. They can also be a good way to enhance the diversification of your portfolio, say, by adding an ETF that specializes in REITs or emerging markets or natural resources.

Given that you've got to shell out brokerage commissions, though, ETFs are not the right choice if you invest relatively small sums of money or if you're planning to regularly sell off small chunks of your portfolio for income in retirement.

But if you're investing a sizeable amount -- an IRA rollover, say -- that you intend to invest over a long time, then I'd say an ETF could easily make sense.

I've given you the abbreviated explanation of ETFs here. For more, I suggest you check out our ETF Center as well as an earlier column I wrote on ETFs and a series of articles on ETFs that appeared on our site earlier this year. (You can get to those articles by clicking here, here and here.)

If, after reading this material, you decide ETFs are right for you, then go ahead and invest. But whatever you do, don't buy in just because the chatter about ETFs is so pervasive that it seems everyone else is.

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Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."

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