What Is a Sector Mutual Fund?
- It's important to used sector funds for diversification. However, to be efficient, an investor should exam a current portfolio for any overlapping in current investments to reduce risk. For instance, Exxon Mobil is a giant in the oil industry and belongs to many energy sector funds. However, Exxon Mobil can be found in many large-cap funds and is a stock that's widely held outright. Investors would take on too much risk if they owned both types of funds and/or the stock outright. Diversification can be done by combining a basic energy mutual fund with a subsector fund such as solar energy.
- Sector funds provide market participation for investors who lack a particular sector in a current portfolio. These funds are cost effective due to grouping hundreds of companies for one central price of the sector fund. Investors use these sector funds to capture growth within a particular sector. Sector funds can serve as a hedging tool as well. For instance, during bear markets, investors could invest in healthcare sector funds, as healthcare is a less volatile sector then technology or retail sectors.
- According to Mark P. Cussen, CFP, CMFC, sector funds tend to have more risk and volatility then broader-based funds or index funds. Some sectors of the U.S. economy historically experience higher highs and lower lows than the economy as a whole. Subsectors can be more volatile than a board sector fund. However, every sector reacts differently at different points of the economic cycle. Tax-conscious investors need to pay attention to sector funds due to a higher turnover rate than other funds. A high turnover rate indicates the fund regularly buys and sells assets in the fund. If profits made from selling an asset then it will be taxed according to the capital gains rate. According to the Internal Revenue Service, the current capital gains rate no higher than 15 percent. However, if capital loss occurs (lose in asset value), then it can be deducted from capital gains.
- An investor can consider sector spiders (SPDRs) or exchange-traded funds (ETFs). These investment options have the diversification of a sector mutual fund but trade like stock on the open exchange. SPDRs and ETFs can also have lower expense ratios then sector mutual funds because sector funds don't have a large asset base. SPDRs and ETFs include more investment options, such as short sales.
- Investors should consult a financial adviser before investing in sector funds. A financial adviser will help analyze a portfolio and construct an investment plan according to the client's investment objectives and risk tolerance.
