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Questions to Ask Before Investing in a Specific Sector

If you’re planning to invest some money and hopefully watch it grow, it pays consider investing in a sector instead of a specific stock. Sectors often make good long-term investments without the risk associated with investing in individual companies. Regardless of what industry you’re planning to invest it, research is needed to make an informed decision. Versing yourself with the ins and outs of an industry separates smart investing from pure gambling on a stock just because the name is well known.

When you set out to invest in a specific sector – from healthcare to financials to energy – there are a few key questions you need to ask to make sure you’re making the right moves that will help your investments pan out.

First, how do I invest in a sector?

Most investment management companies have their own ETFs and mutual funds that invest in the stocks pertaining to a specific industry. Picking one of these funds, whether it’s through a company like Vanguard, Fidelity, Charles Schwab, or the like, is the easiest way to direct your money to a sector.

Each investment company makes it’s sector funds a little differently, although there is some overlap. Take, for example, Vanguard’s Information Technology ETF (VGT) and the iShares Global Tech ETF (IXN). Both funds have Apple (AAPL) making up the biggest portion of the fund. Microsoft is the second biggest for both funds. After that, things change a bit, with Google (GOOG) and Facebook (FB) switching positions. Beyond that, the funds differ more with the remaining allotments. As similar as these funds are, it pays to do a little research to check the differences.

The downside to investing in an ETF or mutual fund is that there are fees charged for investing, beyond the cost of buying and selling the fund. These fees are often small, but can add up over time. Check to see the fees attached to each fund if you’re planning to invest in the long term.

How do I invest outside of an ETF or mutual fund?

You can avoid the fees and invest in the specific companies as you see fit. This DIY route gives you a lot more freedom, but the one-time cost of buying and selling a stock that most investment companies charge might not make this a cost-effective move. If you have an account that allows free trades and like the challenge of building your own sector-based investments, this is the way to go. Just be prepared, as this requires a lot more work and monitoring of your investments.

What factors should I look at?

Some of the most important things to consider when choosing a sector are how future growth and present valuation. Past trends don’t guarantee future results, but looking at the ebb and flow of past years can give you an idea of how the sectors are currently priced. The price to earning ratio will also give you an idea of whether an industry is overvalued or not. Finding bargains is possible if you’re willing to deal with possible long-term volatility.

How volatile is the sector?

Many sectors can stay fairly steady over time, but others deal with seismic events. For healthcare, legislation like Obamacare shakes up the industry considerably. Oil can also undergo big changes due to geopolitical events or promising booms such as domestic product. No matter how you’re investing, it’s always good to be diversified and make sure your portfolio isn’t bogged down with just one industry.

What else can I learn?

Whether you’re choosing a specific ETF or doing the more-demanding individual investments, any knowledge you can glean about the industry is advantageous. One place to get some reliable, but limited, information is from people you know. Trying asking people working in certain industries to get a feel for the sector and to give you some starting points to build research upon.

In a hospital, a nurse would have a good idea of what’s happening in the healthcare industry and what sort of challenges the industry is dealing with. Likewise, a Realtor you know could fill you in on what’s happening with REITs (real estate investment trusts). Such broad information is useful, and definitely does not count as insider trading.

When do I worry?

As well planned as your investment in the sectors of your choosing might be, there’s always the potential of big changes. Sectors are momentum based, and a hot industry could cool off faster than you expect. The industry might quickly skyrocket due to a series of fortunate events, or an outside factor could cause the price to drop. These things happen, and in almost all cases it’s best not to panic. Things will settle down as most of these industries will be around for the immediate future. Still, stay on top of industry trends to see what could be on the horizon.

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