Imagine this scenario: You're looking for investments. You have some extra money -- perhaps $3,000 to $5,000 -- and you've got a hunch, too. You're intrigued by the financial services sector.
You see that Lehman Brothers (NYSE:LEH), Merrill Lynch (NYSE:MER), and Washington Mutual (NYSE:WM) have all fallen by roughly 20% or more this year. You see that Citigroup and Fifth Third have great dividend yields of 4.6% and 4.9% respectively. You're impressed with the net profit margins of Goldman Sachs (NYSE:GS) and Bank of New York Mellon (NYSE:BK), which top 20%. You see the recent subprime-lending mess as a reason why this sector is depressed.
Here's the problem: You don't know which of these companies will fare best in the coming years, and you can't afford to invest in more than one or two at a time. Well, maybe technically you can, but you'd be spreading your money rather thin, and you'd then have to follow more companies than you're willing to. In fact, your lack of time is a major factor behind this dilemma. You just aren't able to dig into each company, even though you're pretty sure that as a group, they have nowhere to go but up -- eventually.
Fortunately, all is not lost. This is one scenario in which exchange-traded funds (ETFs), funds based on indexes that trade like stocks, can come in darn handy.
Consider, for example, the iShares Dow Jones Financials Index Fund (NYSE:IYF). It's invested in nearly 300 major (and not so major) financial services companies, including pretty much every giant you can think of, in banking, insurance, mortgages, credit cards, brokerages, and the like. It sports a dividend yield north of 2%, too. One simple investment in it gives you the financial services industry. (Its top 10 holdings make up roughly 40% of its total asset value, so it's still a relatively focused investment.)
For an even more focused take on the industry, check out the KBW Bank ETF (AMEX:KBE), which is invested in just about two dozen major banking firms and recently was yielding more than 5%.
If you're interested in other industries, you might want to look up what ETFs exist for them.
Finally, you can (and should) read all about ETFs in our ETF Center. They offer some valuable advantages over traditional mutual funds.
