Sector investing has been given a bad rap.
To proponents of traditional asset allocation and broad diversification, investing in single industry sectors via ETFs is tantamount to speculation. Why bet on energy or financial stocks when a broad market index fund already holds these sectors?
Granted, day trading in and out of sector ETFs is indeed speculative behavior. But it’s a misinformed view to assume that tactical trading with sector ETFs is the primary or only way to invest in industry sectors.
Let’s examine three ways that sector ETFs can actually help to reduce market risk and increase cash flow.
Apple (AAPL) is a recent example of what we’ve witnessed time and again; today’s hotshots becoming tomorrow’s turkeys.
The iPad maker’s stock price has dropped around 40% in value over the past eight months. (Wall Street’s analysts still have a laughable average price target of $633 even though Apple is nowhere near those levels)
If an investor really believes in the technology sector and its future prospects for earnings growth, why bet the house on just one horse when you can own many?
That’s where ETFs come in.
The Select Sector Technology SPDR (XLK) owns Apple along with Google, IBM, and 75 other large-cap technology companies within the S&P 500.
The stock-replacement strategy, with ETFs being used in the place of individual stocks, allows an investor to have broader diversification, less volatility, and less single-company risk.
And what about performance? Investment study after investment study continues to prove the vast majority of stock portfolios (managed by both amateurs and professionals) consistently underperform corresponding index funds or index ETFs.
This even applies at the sector level. The stock-replacement strategy isn’t just smarter, but it helps investors avoid the higher investment costs associated with those losing strategies.
Increasing Dividend Growth