ETFs for Shopaholics

While you're doing your shopping this holiday season, consider investing in retail stocks. Exchange-traded funds in particular can give you numerous choices.

In fact, the number of funds in this area can make it downright confusing. Some funds focus on companies selling consumer discretionary goods, while others concentrate on the consumer staples sector. Still other funds split the sector between goods and services, and others look at the sector from a domestic or global view. Purchasing just one fund in this segment, could be like having just one present under the tree.

Getting diversified
Before picking a consumer ETF for your portfolio, you should have a more broadly diversified portfolio that provides wide market coverage. Similarly, but at a secondary level, an investment in the retail sector should start with one of the funds that provides broad exposure to the consumer. Like most concentrated portfolios, an investment in the retail sector is by its very nature more concentrated than a broadly focused ETF. This means the sector ETF will in all likelihood be more volatile and involve greater risk. Sector funds can also carry higher expense ratios that reduce your performance.

What to put in your cart
A number of ETF sponsors offer retail funds, but a look at three of these groups' offerings is a good place to start a search for a fund to put into your shopping cart.

iShares offers two retail funds, the iShares Dow Jones U.S. Consumer Services Sector Index Fund (NYSE: IYC) and the iShares Dow Jones U.S. Consumer Goods Sector Index Fund (NYSE: IYK). Vanguard splits the group between the Vanguard Consumer Discretionary ETF (AMEX: VCR) and the Vanguard Consumer Staples ETF (AMEX: VDC). State Street's SPDRs cover similar territory with its Consumer Discretionary Select Sector SPDR Fund (AMEX: XLY) and Consumer Staples Select Sector SPDR Fund (AMEX: XLP).

Annualized Returns as of 10/31/07

Same sector, different focus
The Vanguard and SPDR funds both approach the sector by dividing it between discretionary goods and staples. As a result, the consumer staples funds both have more than 70% of their assets invested in consumer goods companies, while the consumer discretionary funds similarly have more than a 70% exposure to consumer services companies. Meanwhile, the iShares funds have virtually all of their investments devoted to the sector indicated in their names.

Triple witching
With real estate in a prolonged slump and oil seemingly headed ever higher in price, consumers are squeezed in the middle. A weakening dollar has also raised the cost of imported goods, making it unlikely that retail sales will be outstanding while these three trends are in place.

Consumers are a powerful force in the economy, and owning a fund that focuses on this sector can give you exposure to stalwarts like Wal-Mart (NYSE: WMT) or highfliers like J.C. Penney (NYSE: JCP). Yet until economic conditions improve for consumers, I think consumer nondiscretionary stocks are the more attractive part of this sector. Once the economy comes around, you might want to position yourself to take advantage of the current sale on these stocks by investing in a diversified retail fund and benefitting from the likely rise in values.

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