Pros & Cons of Sector Investing
Sector investing simply refers to targeted investing in a particular market sector or industry. Finance, real estate, utilities, and retail are a few examples of common sectors.
Many institutional investors use a sector investing strategy, but it’s one that individual investors can use as well, either by selecting individual stocks according to a theme or to describe different exchange-traded funds (ETFs) or mutual funds that focus their investments on a single sector.
Common Investing Sectors
Investors who want exposure to the following sectors can either invest directly in companies or assets, or invest in ETFs or mutual funds composed of securities within that sector.
This section focuses on companies that contribute to health care needs and related endeavors.These may include hospitals and related real estate, health insurance companies, pharmaceutical companies, companies that make medical devices, and more.
The precious metals sector is historically seen as a safe haven asset that investors flock to in times of crisis. Even outside of a crisis, companies involved in the exploration of new metal deposits and mining of those deposits can sometimes provide significant returns.
Investors may be keen to find ways to invest in gold, but other examples include mining companies, direct investments in commodities, or in funds ETFs that purchase them.
This sector includes real estate developers and property owners, as well as mortgage-backed securities.
Real estate investors may also choose to put money into real estate investment trusts (REITs), which use investor money to acquire income-producing properties like data centers, office builds, shopping malls, or apartment buildings. One attractive feature of REITs is that they pay out a large portion of their income in the form of dividends to investors.
Utility investing focuses on companies that provide utilities like phone and internet service, electricity, or natural gas. Utilities are considered to be a defensive or safe haven sector, since they tend to do well during a recession because people almost always need the services they provide.
Technology companies have become an increasingly large part of the economy as more organizations continue to undergo digital transformation. Investments in the tech sector might include streaming video providers, computer companies, or social media companies.
This sector focuses on the companies that make or sell items that people need to buy, such as supermarkets, food producers, and convenience stores.
This sector includes companies that make or sell goods that people like to purchase but don’t need, such as e-commerce companies, home improvement, apparel, or sporting goods retailers. This sector tends to perform well during times of economic expansion and to lag during a recession.
This sector focuses on companies that produce or supply energy. That may include oil drillers, coal miners, and pipeline operators. Some energy investors might focus only on stocks in the renewable energy space, such as wind farms or solar panel producers.
Recommended: Investing in Low Carbon Stocks: What to Know
Pros of Sector Investing
Some of the benefits involved in sector investing include diversification and the ability to invest with market cycles.
Investing in multiple sectors of the economy is one method of attaining diversification within a portfolio, which involves investing in many different types of stocks. If some sectors produce outsize gains, they can help offset lower returns in other sectors.
One of the more common sector investing strategies is sector rotation, meaning that investors change their allocation to certain sectors depending on the economic cycle. For example, they might invest more heavily in the utility sector during a recession, when utilities tend to outperform, and move those funds into consumer discretionary goods during a recovery.
Cons of Sector Investing
While sector investing may prove beneficial, it also has its potential drawbacks. Some of the same features that make this strategy profitable or appealing can also make it risky.
Things that impact one sector as a whole tend to affect most or all companies within that sector. As a result, a single relevant event or news headline could have dramatic consequences for those heavily invested. This could result in large moves upward or downward.
For example, imagine being heavily invested in the oil and natural gas sector. Suddenly, the demand for energy plummets because of restrictions on travel, decreased consumer spending, and overall lack of demand for petroleum products. This would likely have a dramatic effect on nearly all companies in the oil and gas sector, leading to potentially large losses for investors with a large exposure to this sector.
On the other hand, if markets became optimistic that a future event would restore demand, or something happened to decrease supply, then volatility could swing the other way pushing up the value of investments.
Recommended: How Investors Can Manage Stock Volatility
Concentration risk is a form of investment risk in which investors over-allocate a portion of their portfolio to a single sector and lose the downside protection that may come with a properly diversified portfolio, which spreads investments across different types of assets to minimize risk.
It is notoriously difficult for individual investors to sustainably engage in stock market timing, in which they can precisely determine the most optimal time to buy and sell a specific investment.
Sector ETF Investing
Investing in sector-focused ETFs is one of the easiest and most common ways to invest in sectors. Sector-specific exchange-traded funds hold dozens or hundreds of stocks within a specific sector, allowing investors to get exposure to the entire sector without having to make investments in individual companies.
Choosing an ETF takes less time and research than choosing many individual stocks. While ETFs may not experience the same level of gains as individual stocks, they also have less volatility.
Sector investing involves making investments in specific parts, segments, or sectors of the economy. There can be pros and cons to doing so, and investors should consider all factors or even speak with a financial professional before making a decision.
To determine the best investing strategy for you, you’ll need to consider your long-term goals, your risk tolerance, financial objectives, and the amount of time and effort you want to spend choosing investments.
Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
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