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If you’re wondering how to invest in the financial sector, exchange traded funds (ETFs) can be a simple way to get started. ETFs that focus on the financial sector invest in companies that are involved in different areas of finance such as banking, insurance, real estate and investment management. You can choose a broad financial ETF that invests in all these areas, or you can choose to invest more narrowly in one of the sub-sectors. By using an ETF, you can invest in a basket of companies without having too much exposure to one individual stock.
The Federal Reserve started hiking interest rates in early 2022 to bring down high inflation. The financial sector has benefited from higher interest rates as banks earn a larger spread on what they pay to depositors and what they earn in loans, but it has also caused problems for some banks. Silicon Valley Bank collapsed after the rise in interest rates caused mark-to-market losses in their bond portfolio, requiring them to raise capital, which spooked customers and led to a run on the bank.
Insurers and investment managers may benefit as their investments yield higher returns. However, income-based investments such as real estate investment trusts (REITs) could struggle in a higher-rate environment as investors demand higher yields to compensate them for risk. A possible recession could also thwart financial sector gains if it leads to losses for banks or weak financial market conditions.
However, some financial sector ETFs may prove to be attractive investments in the coming years if interest rates continue their march higher or stay elevated for a meaningful length of time.
What are the main types of financial ETFs?
Though the financial sector may seem homogenous, there are several different businesses that fall within the financial label. You can invest in a broad financial ETF or choose to focus on one of its sub-sectors.
- Broad financial ETF – This type of fund will hold companies in all areas of the financial sector and will typically be the most diversified option.
- Bank ETF – This type of fund will hold a number of different banks, with major banks such as J.P. Morgan Chase and Bank of America typically making up significant percentages of the fund’s portfolio.
- Insurance ETF – This type of fund will hold companies that provide different types of insurance such as auto, life and property and casualty.
- Capital markets ETF – This type of fund invests in companies involved in capital market activities such as asset management, brokers and exchanges.
- Real estate ETF – This type of fund may hold REITs or other companies involved in the purchase or development of real property such as hotels or office buildings.
What to look for in an ETF
Before purchasing an ETF, it’s useful to know some key information about the fund. Here are some areas to pay close attention to.
- Sub-sector – Make sure you know which sub-sector you’re investing in and the unique characteristics of companies in that industry. Not all financial sector companies respond the same way to different economic conditions.
- Investment track record – Looking at how the fund has performed over short-, medium- and long-term time frames will help give you an idea of what to expect in terms of the fund’s investment return. Of course, past performance is not a guarantee of future results.
- Expense ratio – You’ll want to know how much the fund charges annually because the fee comes straight out of your investment return. Larger funds can often have lower expense ratios because they have a greater amount of assets to spread their costs over.
- Fund holdings – It’s worth peeking at the fund’s top holdings to make sure its actual investments align with its sub-sector and investment objectives. Typically, the holdings will make sense based on the fund description but watch out for holdings that don’t line up with the fund’s name or objective.
Here are some of the best financial ETFs investors should consider. All data is as of June 12, 2023.
Best financial ETFs
1. Best broad financial ETF
Financial Select Sector SPDR Fund (XLF)
This fund seeks to achieve investment performance that tracks the Financial Select Sector Index, which aims to provide an effective representation of the financial sector of the S&P 500. The ETF holds companies involved in a variety of financial activities including banking, insurance, REITs and capital markets.
5-year returns (annualized): 5.7 percent
Expense ratio: 0.10 percent
Dividend yield: 1.8 percent
2. Best bank ETF
Invesco KBW Bank ETF (KBWB)
This ETF invests based on the KBW Nasdaq Bank Index and typically allocates at least 90 percent of its assets in securities that make up the index. Holdings include large money-center banks, such as Wells Fargo and Bank of America, as well as regional banks and thrift institutions.
5-year returns (annualized): -3.1 percent
Expense ratio: 0.35 percent
Dividend yield: 4.2 percent
3. Best insurance ETF
iShares US Insurance ETF (IAK)
This fund seeks to track the investment performance of the Dow Jones U.S. Select Insurance Index. The insurers are involved in life, property and casualty and full-line insurance. Major holdings include Chubb, Progressive and American International Group.
5-year returns (annualized): 8.2 percent
Expense ratio: 0.39 percent
Dividend yield: 1.6 percent
4. Best capital markets ETF
SPDR S&P Capital Markets ETF (KCE)
This ETF aims to track the performance of the S&P Capital Markets Select Industry Index. Companies in the index are involved in industries such as asset management and custody, financial exchanges, as well as investment banking and brokerages. The ETF’s major holdings include Ares Management, Moody’s and Cboe Global Markets.
5-year returns (annualized): 8.8 percent
Expense ratio: 0.35 percent
Dividend yield: 2.3 percent
5. Best real estate ETF
Vanguard Real Estate ETF (VNQ)
This fund aims to track the return of the MSCI U.S. Investable Market Real Estate 25/50 Index. The fund invests in REITs and companies involved in the purchase of commercial real estate, hotels and other real property. Top holdings include Prologis, American Tower and Simon Property Group.
5-year returns (annualized): 4.3 percent
Expense ratio: 0.12 percent
Dividend yield: 4.3 percent
If you’re looking for an easy way to invest in the financial sector, ETFs provide a simple option to achieve that. You can choose a broad financial sector ETF or narrow your approach and invest in ETFs that track specific sub-sectors. Make sure you understand how each sub-sector is impacted by different economic conditions and pay close attention to the ETF’s expense ratio. If you’re just starting out, a broadly diversified fund based on indexes such as the S&P 500 might be a better fit.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.