Investing in the stock market is one of the best ways to generate wealth, but choosing the right stocks can be confusing and time-consuming. Invest in the wrong places and you can easily lose a lot of money.
Fortunately, there’s a simpler strategy that can help you earn above-average returns with less effort than buying individual stocks: investing in sector-specific exchange-traded funds (ETFs).
How ETFs can simplify the investment process
An exchange-traded fund is a basket of securities grouped into a single investment. Each ETF can hold dozens or hundreds of shares, and by investing in just one share of an ETF, you immediately own a share of all the shares in the fund.
ETFs can make it much easier to get involved in the stock market. Instead of researching and buying dozens of individual stocks, focus on buying just one or two ETFs. Not only can this reduce the time you spend on research, it can also save you thousands of dollars.
Because ETFs hold so many stocks, that can also help limit your risk. While investing in stocks in any capacity always comes with risks, greater diversification can keep your money safer. If one or two of the stocks in your ETF plummet, you still have dozens of other stocks that can support your portfolio.
Sector-specific ETFs can boost your savings
There are many ETFs to choose from, and the right choice for you depends on your goals and risk tolerance. If you want to maximize your income, a sector-specific ETF can be a smart investment.
As the name suggests, a sector-specific ETF only contains stocks from a specific sector. For example, if you want to invest in the technology sector, a technology-focused ETF can give you immediate exposure to the sector with more diversification than you could get by investing in individual stocks.
The biggest advantage of these types of ETFs is that they have the potential to significantly outperform the market, giving you much higher-than-average returns over time.
For example the Vanguard Information Technology ETF (NYSEMKT: VGT) – which includes 321 stocks from different parts of the technology industry – has delivered an average annual return of 20.30% over the past ten years. The Vanguard S&P 500 ETF (NYSEMKT: VOO)in contrast, it has delivered an average return of just 12.66% per year over the same time frame.
Because there are so many industry-specific ETFs to choose from, it’s possible to invest as broadly or as narrowly as you want.
For example, if you are interested in general healthcare stocks, you might choose the iShares Global Healthcare ETF (NYSEMKT: IXJ). For a more specific fund there is the iShares US Healthcare ETF (NYSEMKT: IYH). Or if you want to invest in a particular niche within the sector, you can opt for the iShares Biotechnology ETF (NASDAQ: IBB) or the iShares US Medical Devices ETF (NYSEMKT: IHI).
Sector-specific ETFs can be a smart middle ground between individual stocks and broad market funds like S&P 500 ETFs. They can be used to build a more customized portfolio and potentially earn above-average returns, but they don’t require as much time or research as individual stocks.
One big risk to consider before purchasing
Perhaps the biggest disadvantage of sector-specific ETFs is that they carry more risk than broad-market funds that track a wide variety of sectors.
While ETFs can provide significant diversification compared to investing in individual stocks, all of the stocks within each of these ETFs are from the same industry. That increases your risk, especially if you invest in more volatile sectors like technology.
For this reason, it is wise to either invest in several sector-specific ETFs to broaden your portfolio, or to also invest in a broad-market fund that covers a wide variety of sectors. By avoiding reliance on stocks from a single sector, you can further reduce your risk.
Investing in ETFs can be an easier and simpler way to invest in the stock market, and sector-specific funds can boost your income with less effort than buying individual stocks. By building a diversified portfolio and investing wisely, you can earn more over time than you might think.
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Katie Brockman holds positions in Vanguard S&P 500 ETF and Vanguard World Fund-Vanguard Information Technology ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
Do you want to make more in the stock market with less effort? Try This Simple Strategy Originally published by The Motley Fool
