Many mutual funds* and exchanged-traded funds (ETFs) buy stock in companies that represent a broad range of industries and economic sectors. However, some stock funds take a less diversified, more high-risk approach, investing only in companies active in a specific sector of the economy, such as utilities, health care, or information technology.
Background
There are 11 market sectors that have been identified under the Global Industry Classification Standard, a classification system developed by MSCI and S&P Dow Jones Indices to categorize companies traded on public exchanges. This system is recognized by the wider financial and investment community.
The 11 sectors are:
- Energy
- Materials
- Industrials
- Consumer Discretionary
- Consumer Staples
- Health Care
- Financials
- Information Technology
- Communication Services
- Utilities
- Real Estate
Within these 11 sectors, there are 24 industry groups, 69 industries, and 158 sub-industries. Typically, a sector fund will only buy stock in companies that operate in one of these sectors or in a subsector.
Pluses of Investing in Sector Funds
Sector funds allow investors to invest in specific market sectors that may outperform the overall market. Investors can use these funds to try to capitalize on emerging developments and advances in various sectors of the economy.
Sector funds may also be used by investors who are attempting to take advantage of business cycles. Cyclical stocks are sensitive to the health of the economy and their prices tend to move up during periods of strong economic growth. Cyclical companies make goods and provide services that are in high demand by consumers when the economy is strong, such as autos and electronic goods. Defensive stocks are stocks in companies that produce goods and services that consumers keep buying even during a weakening economy. Because the demand for utilities, food, and other staples remains fairly constant through all economic phases, the stock prices of companies in this sector typically do not fluctuate too much during economic highs and lows.
Be Aware of the Risks
Sector funds involve risks associated with a portfolio that concentrates its investments in one sector and can experience extreme volatility. There is a higher risk of loss and investors should expect higher expenses and costs buying sector funds than they would buying an index fund.
In general, sector funds may be appropriate for experienced, informed investors who can handle a high level of investment risk and have a long-term investing horizon. Before investing in sector funds, it may be advisable to own a portfolio of broadly diversified funds.**
As always, be sure to consult with a financial professional before investing, especially in assets that are complex and may present a higher than average investment risk.
*You should consider the fund’s investment objectives, charges, expenses, and risks carefully before you invest. The fund’s prospectus, which can be obtained from your financial representative, contains this and other information about the fund. Read the prospectus carefully before you invest or send money. Shares, when redeemed, may be worth more or less than their original cost.
**Diversification does not ensure a profit or protect against loss in a declining market.
For more information on Sector Funds, call Vista Tax Relief at 480-916-2862 today!