Introduction

Exchange traded funds (ETFs or etf funds for short) have become very popular. They serve the purpose of a mutual fund but have the benefits of investing in a basket of common stocks.

Investopedia defines ETFs as:

securities that track an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. These ETFs experience price changes throughout the day as they are bought and sold.

Index Funds

Another related term is index funds. Wikipedia defines an index fund as:

a collective investment scheme (usually a mutual fund or ETF) that aims to replicate the movements of an index (for example the S&P 500 index) of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions.

Investors cannot invest in the S&P 500 index, however they can invest in SPY which is an ETF that tracks the S&P 500 index.

Sector ETFs

Another term you need to understand is sectors. Investors like to see stocks grouped together based on similarities. Due to these similarities, companies within a sector often experience similar movements in their stock prices. Not all financial businesses use the same grouping of sectors. For example, Yahoo identifies 9 sectors. Others list as many as 12 sectors. Yahoo’s list of sectors is an excellent resource. Sector ETFs invest in a basket of stocks within the same sector. Common sector ETFs and their stock symbos are as follows:

• XLE — Energy
• XLF — Financial
• XLI — Industrials
• XLK — Technology
• XLM — Basic Materials
• XLP — Consumer Staples
• XLU — Utilities
• XLV — Healthcare
• XLY — Consumer Discretionary
• IYZ — Telecommunication

Summary

Approximately 75% of all U.S. stocks are in one of the above ten sector exchange traded funds. The economy fluctuates over time and money generally flows between sectors. Following are some examples of this flow:

In recessionary times, money flows into defensive stocks in the consumer staples and utilities sectors.

Coming out of a recession, money flows into technology stocks or other growth-oriented stocks.

By paying attention to the sectors and relative sector performance, we can get a good reading on what is going on in the economy and in the market. By paying attention to the sector etf funds and sector performance we can get a good read on where the best investment opportunities can be found.