The Fate and Origin of the Istari

[Legolas]

There is a whole chapter in Unfinished Tales dedicated to the Istari (as well as a small portion in HoME XII). Highly recommended reading.

but why were only five chosen?

Because they didn't need to send an army to fill the purpose - they were only sent as guides. Manwe only planned on sending three originally.

how/why were those five sent?

Their mission was to guide the free people of Middle-earth against Sauron. They were guides, counsellors to unite those people - not to fight Sauron, for Middle-earth had to learn to stand up for its own good. Little would be achieved if the Valar swooped in and saved the day everytime an evil-doer popped up. If they had been sent to combat Sauron directly, the five would've marched down to Mordor, faced off with him, and returned home in time for dinner.

It was afterwards said that they came out of the Far West and were messengers sent to contest the power of Sauron, and to unite all those who had the will to resist him; but they were forbidden to match his power with power, or to seek to dominate Elves and Men by force or fear.

their emissaries were forbidden to reveal themselves in forms of majesty, or to seek to rule the wills of Men and Elves by open display of power, but coming in shapes weak and humble were bidden to advise and persuade Men and Elves to good, and to seek to unite in love and understanding all those whom Sauron, should he come again, would endeavour to dominate and corrupt.

They were selected in a meeting the Valar held in Valinor. Of the Maiar, three were to be sent as emissaries. When Manwe asked for volunteers, Alatar and Curumo (Saruman) stepped forward. Then he asked where Olorin was, a Maia of his own people, but Olorin was reluctant to go, for he was humble and estimated Sauron as greater than he - Manwe saw this as more reason for him to go, and proved correct in his assessment that Olorin would prove the better of the two. Yavanna insisted that one of her own people go, Aiwendil, known as Radagast in Middle-earth. Alatar requested that his friend Pallando be allowed to accompany him; both are Maiar of Orome. Manwe granted both requests.

Saruman did *not* return to Valinor. He was slain, and due to the nature of the Istari and their incarnation, they could die like this (just as Gandalf did, and Sauron).

Whereas Curunír was cast down, and utterly humbled, and perished at last by the hand of an oppressed slave; and his spirit went whithersoever it was doomed to go, and to Middle-earth, whether naked or embodied, came never back.

It is reasonable to presume that Radagast may have returned to Valinor. Of Alatar and Pallando, I would say it depends on their path - how entangled in evil they may have become in the East.

For info on Radgast and the Blue Wizards see the Middle-earth FAQ I've written on them.