Focused diversity. How’s that for an oxymoron? But that’s exactly what sector funds try to provide by bridging the gap between individual stocks and broad index-based mutual funds and exchange-traded funds (ETFs). These funds let you pick an individual sector in which to invest, and avoid some of the company-specific risk that comes with picking individual stocks. But which sector should you pick? This article will examine sector funds that invest in the financial industry and the advantages and disadvantages that securities in this sector can present to investors. (To begin with the basics, see An Introduction To Sector Funds .)

Why Invest in Financial Sector Funds?

The financial sector is more than credit products and savings accounts. This sector encompasses investments, insurance, mortgages, banking, derivatives. venture capital. accounting and it is also intertwined with real estate. It is an industry essential for the economic wellbeing and financial strength of a country. (For more information on this sector, see The Evolution Of Banking .)

Financial funds provide easy market participation for investors whose portfolios lack exposure in this sector. They can also provide a greater measure of diversification within the financial industry than may be otherwise possible. Some financial mutual funds focus on specific subsectors of the financial industry, such as banking or mortgages. Others cover a broader spectrum and invest in either several or all of the subsectors within the industry.

To diversify most efficiently, planners should carefully examine possible overlap between any potential sector fund and the client’s current portfolio, so that any financial fund that is chosen contains the fewest possible stocks that are already held by other funds owned by the client. For example, the stocks of major financial conglomerates are often found in many mainstream growth and/or growth and income funds, and therefore more specialized financial funds that invest in specific subsectors may diversify the client more efficiently. (For more on managing your investments’ exposure levels, check out Introduction To Diversification .)

Historical Performance

The financial sector essentially reflects the economic activity of the rest of the world. In a sense, the rise and fall of all other sectors both domestic and international have a direct impact on the performance of this sector. This is reflected in both the Morningstar Financial Services Fund Index from 2003-2008 and the Standard & Poor’s Financial Select Sector SPDR. which has traded since 1998. The historical performance of both indexes indicates that the financial sector generally mirrors the performance of the mainstream indexes like the Dow Jones Industrial Average and the S&P 500 .

Although historical performance shows that the financial sector has been slightly more volatile than the overall markets, it has been much less volatile than other sectors such as the technology or energy sectors. But in terms of cyclical analysis, financial funds have moved largely in tangent with the economy as a whole.