What are sector funds, and how do they affect my retirement account?
For this week’s article, I want to start out by thanking everyone for their questions and comments regarding our investment articles. Based on your feedback, I thought it would be helpful if I did another investment definition; and this week I will cover sector funds.
As their name implies, sector funds are mutual funds that invest in a particular sector of the market. For example, Fidelity Select Health Care invests only in health care companies. The idea behind these funds is to allow investors to bet on specific sectors of the market. Sectors funds can give you access to a manager that only focuses on that particular industry or country which can work to an investor’s advantage.
They are more volatile and carry more inherent risk since they are focused investments. This focus can magnify your gains and losses. For example real estate stocks averaged 25.9% from 2003 through the end of 2006 compared with S&P 500, a common benchmark for the overall market, which averaged 12.5%. This changed last year as real estate stocks underperformed the S&P 500 by 20.1%.
Sector funds can serve a unique purpose in a diversified portfolio. They can provide diversification within a specific industry or country with a limited amount of investment. Sector funds can serve as a hedge as some industries do well during different parts of the business cycle. For example, stocks of companies that produce products such as toothpaste and paper towels do well during bear markets because these are products that consumers buy regardless of how the economy is doing.
Typically we do not include sector funds in our recommendations due to the focus of their investments. However, if you do decide to invest in a sector fund, we recommend limiting your investment to no more than 5% of your overall portfolio to ensure you maintain your proper risk level.
If you have any questions, please feel free to contact us by email at info@smart401k.com or by phone at 877.627.8401. Or, if you have any investment topics you would like us to help explain or define, please let us know.
Buck Wendel, Investment Advisor
