Mutual Funds - The Economic Cycle of Sectors

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

Jun 9, 2008: A crucial step in creating long-term wealth is to have a diversified portfolio that would behave reasonably well under various market conditions. Many experienced investors spice up their portfolio with few sector funds which have a potential to fetch above average returns.

Sector funds are those mutual funds that invest within a specific economic sector or industry such as Biotechnology, Financial Services, Natural Resources, Retail, Utilities, Health Care and more. As we can easily guess, sector funds are more volatile and unpredictable than typical Buy and Hold funds that invest in a particular style such as Large Cap Value or Mid Cap Growth.

Then why on earth would we like to invest in them?

Often it has been observed that a particular industry had led a market upswing with equities in that specific group doing exceedingly well than the market average. Therein exists a window of golden prospect to enhance the returns of a diversified portfolio. To make good of such an opportunity, sector investors need to:

• Invest in the right sector at the right time

• Be committed to doing research on the sectors

• Stay informed about the economic climate in the specific industries

• Diligently rotate their investments among various sectors judiciously

• Have high tolerance for risk

To help us develop a simple strategy for sector investing, here is a repetitive economic pattern. Figure 1 depicts a typical economic cycle. It highlights the stages at which different industries tend to beat the market average. This figure is based on past data and does not convey any current or future economic outlook.

Figure 1: A Typical Economic Cycle for Sectors

We can use the Figure 1 as a broad guideline to focus on a specific sector's economic cycle. But we should always remember that we need to be active and knowledgeable investors to ace sectors.

Do you invest in sector based mutual funds? Which ones have worked for you? Please feel free to share your sector based investing experience with us.

Image Source(s): Personal Fidelity

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