American banks are some of the longest-standing publicly traded firms in the world, many with histories that date back to well over 100 years. Banks are often regarded as safe investments, especially deep-pocketed companies like JPMorgan Chase and Goldman Sachs.
Bank profits have been steady in the 10 years since the Great Recession but the number of banks in the U.S. has shrunk since 2002. The number of FDIC-insured commercial banks has declined every year since 2002, according to research from Statista.
Large institutions swallow up smaller ones and regulation compliance continues to get more and more expensive. The number of U.S. banks hasn’t been in steady decline for just the last few years. No, this consolidation began over 3 decades ago. When the baby boomers were coming of age, over 18,000 different banking institutions existed in the U.S.. In 2017, that number dipped below 6,000 for the first time in a generation.
The banking industry remains ripe for further consolidation. But if you want to get a slice of these profits, buying individual bank stocks is like a dart-throwing game. Which bank is the next buyout candidate? How much risk can the large banks take on before buckling?
If you don’t have (or want) the answers to these questions, investing in financial ETFs is a good way to gain exposure to the sector without ramping up the risk.
Quick Look – Best ETFs to Watch Out For
- Fidelity MSCI Financials Index ETF (FNCL)
- Vanguard Financials ETF (VFH)
- SPDR Financial Select Sector ETF (XLF)
- SPDR S&P Regional Banking ETF (KRE)
What are Financial ETFs?
Exchange-traded funds (ETFs) are securities that act like both a stock and a mutual fund. A financial ETF is a basket of bank stocks grouped together like a mutual fund, but traded on an exchange like the NYSE or NASDAQ. Buying a financial ETF allows investors to get exposure to the entire banking sector, not just a handful of individual banks.
Not every financial ETF contains the same basket of stocks. Some aren’t even managed by humans. Many ETFs track an underlying stock index without the help of a stock-picking manager. Index funds are often cheaper than actively managed ETFs, so you’ll be seeing plenty of examples later in this article.
Financial ETFs come in a number of different flavors, too. Some focus on large national banks; others focus on regional banks or financial services firms. And of course, some just buy the whole darn sector.
As always, the important features to look for when shopping for ETFs are fees and assets under management.
History of Financial ETFs
Like many sector ETFs, the first financial ETF was a spider. No, not the eight-legged variety, but the acronym. Standard and Poor Depository Receipts (SPDR) was the name given by State Street Global Advisors to the first fund to track the S&P 500 index. The fund was launched in 1993 and today trades under the stock ticker SPY.
State Street launched 10 completely new ETFs in 1998 that concentrated on specific market sectors, such as financials, utilities, energy and technology. Investors used ETFs to invest in sector-specific strategies and the first official financial ETF was born. It still trades today under the ticker XLF.
Today, the ETF market is dominated by the SDPRs, BlackRock’s iShares family, and Vanguard funds, and for good reason. Funds from these firms usually have the lowest fees and plenty of liquidity.
Thinking about adding financial ETFs to your portfolio? Consider a few of the following things first.
Why You Might Want to Buy It
Here are reasons you may want to add financial ETFs to your portfolio.
- Less risky than buying single bank stocks: Buying individual stocks is always risky, but getting exposure to the banks used to be more difficult. Now that dozens of ETFs cover the sector, investors can get exposure to different kinds of banks and financial firms in one package.
- Higher dividend yield than other sector ETFs: Bank stocks pay better dividends than most sectors, so you’ll be rewarded with solid yields when you buy financial ETFs.
- Better vehicle than mutual funds: Not only can ETFs be traded on exchanges, but their expenses are lower and the tax burden on investors has decreased thanks to a lack of capital gains.
Considerations Before You Buy
Make sure to consider these points before buying.
- Reinvest dividends with a cost: Expect to incur transactions costs like trading commissions. Mutual fund dividends can automatically be reinvested in the fund without being subject to fees or commissions.
- Higher expense ratios than broad market ETFs: Financial ETF fees have come down considerably in recent years but the cheapest is still twice as expensive as broad market ETFs from Vanguard, Fidelity, iShares or Charles Schwab.
- Many still haven’t recovered from 2008: Most financial ETFs track the largest banks in the U.S. financial system. Because of this, financial ETFs took the brunt of the Great Recession’s bodyslam and many funds have yet to reclaim their pre-recession highs. Just look at some of the charts of the long-standing ETFs below — many haven’t made new all-time highs in a decade.
Financial ETFs to Keep an Eye On
Always remember to compare expense ratios, assets under management, trading volume and dividend yield when adding financial ETFs to your portfolio. Watch for the following ETFs in 2019 thanks to a combination of these 4 factors.
Fidelity MSCI Financials Index ETF (FNCL)
Fidelity recently launched a new line of zero-expense ETFs, so it should be no surprise that its financial ETF has the lowest expense ratio on our list at 0.08%. Launched in 2013, FNCL already has more than $1 billion in assets and trading volume averages 144,000 shares per day.
FNCL has a dividend yield of 2.23% and holds 405 different American financial stocks. JPMorgan Chase, Bank of America, and Berkshire Hathaway are the largest holdings, but FNCL also offers exposure to smaller firms (unlike competitor XLF). The top 10 holdings comprise 42% of the total portfolio.
Banking services make up nearly 50% of the portfolio, with insurance firms taking up another 29% and investment banks sitting at 16%. In our opinion, FNCL is the best combination of expenses, liquidity and yield in the financial ETF market today. If you can only buy one financial ETF, make it FNCL.
ETF 2: Vanguard Financials ETF (VFH)
Of course there’s a Vanguard fund on our list. You didn’t think you read an entire article about ETFs without seeing them, did you? Established in 2004, the Vanguard Financials ETF provides cap-weighted exposure to the broad U.S. financial sector at a modest price.
At 0.10%, VFH’s expense ratio is bested only by Fidelity’s FNCL. The fund currently has over $7 billion in assets and 445,000 shares are traded daily on average. The dividend yield is about equal to FNCL at 2.23% and the top 3 holdings are again JPMorgan Chase, Bank of America and Berkshire Hathaway.
The expense ratio and lack of daily portfolio disclosures are the only things keeping VFH from the top spot on our list. However, if you’re a Vanguard account holder and can trade VFH commission-free, use that opportunity and buy it instead of FNCL.
ETF 3: SPDR Financial Select Sector ETF (XLF)
Sometimes the original flavor remains one of the best. XLF might be a great combination of low expenses and high liquidity, like most SPDRs.
XLF has an expense ratio of 0.13% and an impressive $22.75 billion in assets. The fund contains only 69 stocks and focuses primarily on large U.S. financial firms. Berkshire Hathaway is the largest holding, followed by JPMorgan Chase, Bank of America, CitiGroup and Wells Fargo. Banking services and insurance firms make up 47% and 32% of the fund’s holdings.
XLF has no equal when it comes to liquidity. Not only does the fund have nearly $23 billion in assets, but 42 million shares are traded daily on average. XLF is a great ETF for investors who seek extra exposure to America’s biggest banks.
ETF 4: SPDR S&P Regional Banking ETF (KRE)
Another SDPR, KRE, makes the list, but this offering from State Street focuses on a completely different segment of the market. All 3 funds mentioned above are cap-weighted and heavily tilted toward the biggest financial firms in the U.S. The S&P Regional Banking ETF is an equal-weighted index fund that concentrates on smaller banks that only operate in certain areas of the country.
KRE is the most expensive fund on our list at 0.35%, but it accesses a portion of the financial sector its competitors don’t touch. The fund holds 123 different stocks and no concentration is higher than 2.6%. The top holdings are names like Synovus Financial, Signature Bank and Fifth Third Bancorp, but the riskiness of these small firms is mitigated thanks to the equal-weight structure.
The dividend yield of 2.34% softens the blow from the high expense ratio and the fund holds nearly $2 billion in assets.
Looking for liquidity? KRE shares are traded over 6 million times per day on average. KRE is a great financial ETF because it actually gives exposure to regional banks, but doesn’t pile weight onto any one firm.
Putting Financial ETFs into Your Investment Plan
Financial ETFs are great for adding bank exposure to your portfolio while keeping risk to a minimum. But like any investment, you’ll need to plan where these products fit in your portfolio before buying. Many of the best financial ETFs have overlapping holdings and concentrate primarily on the large-cap bank stocks.
Buying an ETF is less risky than purchasing a handful of bank stocks and hoping for good earnings reports (and no scandals). Use the ETFs on this list as a starting point if you want financial sector exposure but don’t want to pick stock. Just keep your personal investment goals in mind before buying anything.