Diversified ETFs vs. Sector Funds

February 13th at 6:00am by Tom Lydon

When is comes to exchange traded fund investing, there are plenty of approaches to take. The diversified, broad-based fund has many benefits, however, a sector specific fund can take portfolio construction to a new level.

A sector-focused fund contains shares within a specific area of the market such as pharmaceuticals, consumer discretionary or technology, for example. They can also hone in on specific countries or nowadays, a specific sector with a certain country, according to Investopedia. If the certain sector performs well, a portfolio can make substantial gains, however, if the sector tanks, so does the portfolio. [Worst to First: Financial, Materials ETFs Lead Markets]

A sector ETF can pinpoint an area of the market and give an investor diversified exposure to a basket of related companies. This can be a good strategy over single stock picking, especially if the sector is volatile. For instance, the biotech sector is filled with up-and-coming companies, where about 50% do not make it in the long run. A biotechnology-focused ETF can give investors exposure to many companies in the sector, mitigating the risk of a bankrupt stock.

Many investors are inclined to use a diversified ETF, one that is broad-based and covers many sectors in one shot. These so-called plain vanilla funds can be a core holding in a portfolio and can also stand alone. A fund that holds 30 U.S. large-cap stocks is diversified against company specific risk however, there is risk in being overexposed to too many large-cap stocks.The expense ratios for these types of funds tend to be lower than the sector-specific funds. [State Street lowers Expenses on Sector ETFs]

There are also diversified country-specific ETFs that give investors various exposure to the target country. The choices are varied from Japan, to Great Britain and even Australia. The exposure to other economies can be essential to a properly diversified portfolio. [January Barometer Bodes Well for Stock ETFs]

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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