If you want to beat the stock market averages over time, one way to do it is to invest in the best sectors of the market. Some mutual funds and exchange-traded funds (ETFs) invest in sectors that tend to grow more rapidly than the economy.
Learn more about these sectors and why they have such a good outlook.
Beat the Market With Sector Funds
You may hear about investors, traders, or fund managers trying to "beat the market." This phrase means that they are searching for returns that beat a broad market index, such as the S&P 500. As an investor, you want to get the highest returns possible with the least amount of risk. To do that, you'll want returns that are higher than the S&P 500 or Dow Jones Industrial Average. One way is to invest in market sectors that perform higher than the indexes. Sector funds are among the best ways to invest in areas with higher returns.
No one knows which stocks or sectors will beat the indexes. The best you can do is to look at past returns and make a few guesses about the future. Some market sectors you can look into include technology, health care, financials, consumer staples, consumer discretionary, industrial, energy, and utilities.
Choosing the best sectors to buy for future returns doesn't take luck or a large amount of research. All it takes is a brief study of trends and a bit of research on past performance. To do that, look over each sector, and choose three that have performed higher than the S&P 500 over the past 10 years.
Health Care Sector
An aging population and rapid advances in biotech make the health care industry a tempting option. This space has led all other sectors in growth over the past decade, and it will no doubt continue that trend in the future.
The health care sector is considered a "defensive sector," or one that isn't affected as much by recessions.
The health care sector is quite broad. Its businesses include hospital conglomerates and institutional services. Other firms in the industry are insurance companies, drug manufacturers, biomedical companies, or medical instrument makers.
Many sectors are doing poorly due to weak economic conditions. The health care industry performs well because people still need to see their doctor and get medicine, regardless of the state of the economy.
The tech sector is at the tip of the innovation spear. It is also the driver for the information and data explosion. Tech has shaped the economy for decades. This trend looks to continue for many more, due to non-stop research.
Less than 15 years ago, there was no such thing as an iPhone. Keep in mind that other tech and tech companies will come along with new products and services.
The tech sector is a group of stocks that contains computer hardware manufacturers and many other companies that make software and various electronics. They also provide services and support for their products. Most tech companies also offer information products and/or business data processing.
Consumer Discretionary Sector
The consumer discretionary sector includes firms that provide products and services that are more for luxury or pleasure. Also called "consumer cyclical stocks," they are seen as cyclical because demand for products and services in this sector tends to be higher during certain times in the business cycle, such as the growth phase.
Consumers tend to demand products and services when they have more money and feel hopeful about their jobs and finances. When the economy shrinks, the demand for these stocks also declines.
The returns of the past do not guarantee future results. You can choose to invest in sectors that have performed better in recent history. It's possible that the health care and tech sectors will keep up their growth trends, but there is no guarantee.
Before buying sector funds, you should keep in mind that putting too much capital into one sector can increase the risk to your portfolio. You also should not try to time the market in the short term.
One good portfolio strategy with sector funds is to add them as satellites to diversified core holdings. That way, you're not putting all of your eggs in one basket, so to speak; you're simply putting more eggs in a few more select baskets.
Frequently Asked Questions (FAQs)
When is the best time to invest in defensive industries if you're using sector rotation?
Defensive industries are meant to prevent steep losses during downturns, so the best time to invest in the sector is when the business cycle is at its peak. In reality, it's extremely difficult to recognize a peak as it's happening, but if you can manage to pivot to defensive sectors just before or at the peak of the business cycle, then you may be able to protect yourself from some losses.
How many sectors are there in the stock market?
The Global Industry Classification Standard recognizes 11 sectors. They are energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, communication services, utilities, and real estate.
How do you identify top-performing sectors?
Identifying top-performing sectors is similar to identifying top-performing stocks. Charting and technical analysis can help you identify which sectors are in an uptrend. One of the easiest ways to analyze sector performance is to look at the charts for corresponding ETFs. For example, XLV tracks the health care sector, and technical analysis on XLV's price action can give you insight into the health care sector as a whole.
The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.