What Is a Sector Fund?

What Is a Sector Fund?
Concentrate and focus. No need to strain yourself; I’m describing a sector fund.

A sector fund is a mutual fund or exchange-traded fund that concentrates its investments in a single sector of the market. A sector is a slice of the market that is focused on the same line of business. For example, Bank of America is in the financial services sector, while Wal-Mart is in the consumer services sector.
Three Common Characteristics of Sector Funds

There are three characteristics that are common among sector funds:

1. Focused on stocks within a certain business or industry
2. Concentrated number of holdings
3. More volatile than the overall stock market

How Many Sectors Are There?

It depends who you ask. There are several organizations which have formally divided the market into various sectors and subsets of sectors. In other words, Wal-Mart is in the consumer services sector, but it can be further categorized as a discount store. Bank of America and Allstate are both in the financial services sector, but upon further categorizing, Bank of America is in the banking sector while Allstate is in the insurance sector. You can invest in most of these sectors through a mutual fund or exchange-traded fund.
Morningstar Sectors

As for sector fund investing, Morningstar takes a stab at labeling the various categories of sector
funds in eight categories:

1. Technology
2. Financials
3. Communications
4. Utilities
5. Natural Resources
6. Healthcare
7. Real Estate
8. Precious Metals

Trendy

Although Morningstar’s eight sectors are helpful in categorizing sector funds, the trend has been to identify an increasing number of sectors and create products (mutual funds, exchange-traded funds, etc.) based on those sectors. Your head might spin when you’re trying to pick a fund in the healthcare sector. In that case, you might run across a fund focused on identifying companies that develop products and services that detect and treat cancer. You can also buy a fund that focuses on investing in companies that manage nursing homes and hospitals.
Should I Invest in a Sector Fund?

Should you invest in a sector fund? It depends. Do you want to try picking the hottest sector of the next decade? In 1999, the technology sector was all the rage until it stumbled in March 2000. The NYSE Arca Tech 100 Index (an index comprised of stocks of technology-related companies) is down 20% from December 1999 to December 2008.

Despite the volatility of individual sectors, such as the technology sector, investors may find sector funds useful depending on their needs.
Sector Funds for Diversification

If you’re planning a steak dinner and only have a salad on the side, you might want to add another dish—I like sweet potato casserole. Just the same, if you have a 401(k) that has limited investment options and you find yourself with a lack of representation in one sector or another, you can turn to sector funds in your IRA or brokerage account to fill the void.

If you invest in individual stocks and you’re uncomfortable investing in stocks within a particular sector, then you may benefit from sector funds. You can diversify your portfolio by adding the neglected sector via a sector fund.
Sector Funds for Speculation

Speculative investing entails placing bets on stocks or funds that you think will soar in value. It’s a risky proposition, as speculators generally try to make huge profits in a very short period. Although I am not a fan of speculative investing, if you want to speculate with a small portion of your portfolio based on a hunch you have about a particular stock, you might be better off buying the sector fund that holds the stock. That way, if you’re wrong about the stock, at least you are diversified among your other holdings.
How Do I Invest in a Sector Mutual Fund?

Many fund companies offer sector funds. Fidelity has 43 sector mutual funds and Vanguard has more than 30 sector funds -- including mutual funds and ETFs. Clearly, there is no shortage of sector funds. If you decide to make a sector bet, do your homework and make sure you are well diversified.
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