- Looking at your stock investments through the lens of sectors and industries may help you be better informed about your portfolio.
- Comparing your investments by sector to the sector breakdown of major stock indexes can help you identify where you may be over- or underexposed relative to a broad market benchmark.
Looking at the stock market as a collection of sectors may help you better understand your portfolio, as well as develop strategies for getting exposure in specific sectors and industries to match your objectives.
If you missed Fidelity's webinars on May 25, "Sectors: Hot or Not" and "Research Best Practices: A Focus on Sectors", here's a rundown of takeaways from the events.
What is a sector?
A sector is a segment of the economy made up of a group of businesses that produces similar products or services. The most widely used classification system for sectors is the Global Industry Classification Standard (GICS) system, which breaks the US economy down into 11 sectors: information technology, health care, financials, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, real estate, and materials. Each sector is further divided into industries—for example, consumer staples can be separated into industries including beverages, household products, and food products.
Dividing the economy into sectors, and then further into industries, can help investors analyze the economy in parts to help build a diversified portfolio.1 Historically, different sectors have exhibited unique risk/reward characteristics. Comparing sectors or industries to other sectors or industries within similar time frames can help illuminate potential areas of opportunity. Additionally, comparing sectors and industries against their own history can yield potentially useful insights.
Addressing your sector allocation
Looking at your portfolio through a lens of sectors can help identify areas of over- or underexposure. Investors can compare the sector breakdown of their portfolio to that of common stock market indexes, such as the S&P 500. Comparing your weighting to that of an appropriate benchmark can help show how your portfolio compares to widely regarded markers of the stock market.
This strategy can also help you shape your investment strategy. If you are bullish on the information technology sector, for example, you may want to tilt the tech exposure in your portfolio to be higher than that of an index to some degree. This strategy also holds true within industries in a sector. If your research points towards a potential opportunity in a particular industry, such as beverages within consumer staples, for example, you may want to overweight your portfolio further with securities that fall under that industry. Of course, you should be aware of concentration risk to a particular sector, if you elect to allocate a significant percentage of your funds to an individual sector.
Breaking your portfolio down by sector, and further by industry, and comparing your holdings to economic indexes can help provide a framework to better understand your exposure and help inform how future investments fit in with the entirety of your portfolio.
Investing in sectors through funds
Mutual funds and exchange-traded funds (ETFs) can help you gain exposure to a given sector or industry. Here, we will use ETFs to illustrate how they can help you invest in sectors, although mutual funds could be used as a different tool for sector exposure.2
An ETF is a basket of securities you buy and sell. ETFs vary in portfolio composition, but many track indexes and sectors. Investing in sector-specific ETFs allows for exposure to many stocks within a sector—some ETFs may be composed of hundreds of different securities in a specific sector or industry. The wide scope of a sector ETF can help reduce the risk associated with investing in individual stocks, though a sector concentration risk remains.
Another advantage to investing with sector-focused ETFs compared to individual security ownership in the equity portion of your portfolio is that you may be able to more easily fine-tune your portfolio to match your risk tolerance and sector preference. For example, a growth-oriented investor who favors the technology sector could overweight their portfolio with a technology ETF without incurring some of the concentration risk of individual securities. A more conservative investor could overweight the utility sector, which has historically exhibited less volatility than cyclical sectors like technology and consumer discretionary.
What to consider before investing in an ETF
If you are interested in exploring ETFs to achieve your investing objectives, your next step should be to research them further. And always remember to evaluate an ETF's costs, including the following:
- Expense ratio: Look for low expense ratios to help reduce your overall costs.
- Bid-ask spread: Look for small bid-ask spreads to help reduce costs of investing.
- Tracking error: Look for a low tracking error to find ETFs that indicate a better job of replicating their benchmark indexes.
If you find ETFs with similar objectives, you could compare their expense ratios, bid-ask spreads, and/or tracking error to help find the better option. You can filter for all of these factors using the Fidelity.com ETF Screener.
Knowing the individual components of an ETF can also give you a better sense of what you are buying or selling. You can find an ETF's components on its ETF snapshot page on Fidelity.com, under Portfolio Composition. On that page, you can find the ETF's style (value, growth, or blend) and size (large, mid, or small), as well as ratings and key statistics.
Finally, you should fully understand the risks involved in any investment strategy. Any investing opportunity should be considered within the context of a well-diversified investment strategy that conforms to your specific time horizon, objectives, and risk parameters.
To learn more about tools at Fidelity that can help you understand how sector investing can fit into your portfolio, visit the sector investing page on Fidelity.com.