Sector exchange-traded funds (ETFs) provide access to a wide range of companies in a specific sector. These investment vehicles can be useful for expressing trading views or implementing a sector rotation strategy, which means moving capital between sectors. Investors can benefit from targeted exposure and long-term economic trends by focusing on particular sectors. Here’s a guide to how sector ETFs work and how you can invest in them.
Sector ETFs Explained
Sector ETFs are exchange-traded funds that track a group of companies that are in the same industry sector. These companies usually offer similar products or services that can be differentiated from other sectors. For example, technology ETFs track companies that are in the technology sector. You can invest in any sector ETF by buying shares in the exchange-traded fund through your broker. In comparing sector ETFs and index funds, sector ETFs do not necessarily have to track an index.
A Deep Dive Into Sector ETFs
Sector ETFs are a diversified, cost-effective way for investors to focus on a specific industry, as opposed to other ETFs that may have different themes. Some sector ETFs focus on subgroups within a sector, like cloud computing within technology. Other sector ETFs include global stocks.
The Potential Benefits of Sector ETFs
Several benefits can come with investing in sector ETFs.
Investing in a sector ETF can give you exposure to a broad range of companies within a particular sector. Spreading out your risk means you can hedge against market volatility holding a basket of stocks rather than selecting individual stocks.
Transaction costs on ETFs tend to be cheaper compared to other investment vehicles. ETFs are useful for passive investing, which means you do not have to actively manage your portfolio.
Risk Considerations Before Investing in Sector ETFs
Before investing in sector ETFs, there are several factors you need to consider.
Each sector reacts differently to a given economic cycle. For example, during a recession, the sector you previously invested in, might do poorly.
Though there may be different ETFs tracking a particular sector, the composition of the fund could be different. Fund managers have different portfolio construction methods, and you can check the holdings of the ETF before you invest in it.
Sometimes investing in sector ETFs may not be ideal for you, especially if you already own single stocks. This means you are exposed to that particular sector, which increases your risk. For example, if you have tech stocks in your portfolio, then investing in an ETF that tracks the technology sector could overexpose you to that sector.
Sometimes fund managers include stocks of companies outside of the U.S., as long as they are in the same sector. Investing in such an ETF exposes you to geopolitical risks. In many cases, the exposure to companies outside the U.S. is minimal and may not have a significant effect on the overall performance of the ETF.
Gain Market Exposure Through Sector ETFs
Investors can use sector ETFs to gain exposure without buying every single stock in the sector. Trading sector ETFs allows you to perform sector rotation as market conditions change. Rather than selling and buying a basket of individual stocks, you can trade a single ETF.
Frequently Asked Questions
Are sector ETFs a good investment?
Sector ETFs can be a good investment if you want broader sector exposure.
Do sector ETFs pay dividends?
Yes, sector ETFs can pay dividends. If the fund contains dividend stocks, then investors will get dividends.
How many sector ETFs should you own?
The number of sector ETFs you should own depends on your capital, investment strategy and risk tolerance.