You don’t need to be a stock market expert to earn above-average returns.
Investing in the stock market is one of the best ways to generate wealth, but choosing the right stocks can be confusing and time-consuming. Invest in the wrong places, and you could easily lose a lot of money.
Fortunately, there’s a simpler strategy that can help you earn above-average returns with less effort than buying individual stocks: Investing in industry-specific exchange-traded funds (ETFs).
How ETFs can simplify the investing process
An exchange-traded fund is a basket of securities grouped together into a single investment. Each ETF may contain dozens or hundreds of stocks, and by investing in just one share of an ETF, you’ll instantly own a stake in all of the stocks within the fund.
ETFs can make it much easier to get involved in the stock market. Rather than researching and buying dozens of individual stocks, you can focus on buying just one or two ETFs. This can not only reduce the time you spend researching — it could save you thousands of dollars, too.
Because ETFs contain so many stocks, that can also help limit your risk. While investing in stocks in any capacity always carries risk, greater diversification can keep your money safer. If one or two of the stocks in your ETF plummet, you still have dozens of other stocks helping to prop up your portfolio.
Industry-specific ETFs can supercharge your savings
There are many ETFs to choose from, and the right one for you will depend on your goals and risk tolerance. If you’re looking to maximize your earnings, an industry-specific ETF may be a smart investment.
As its name suggests, an industry-specific ETF only includes stocks from a particular industry. If you’re looking to invest in the tech sector, for example, a tech-focused ETF can give you instant exposure to the industry with more diversification than you might get by investing in individual stocks.
The biggest advantage of these types of ETFs is that they have the potential to significantly outperform the market, helping you earn much higher-than-average returns over time.
For example, the Vanguard Information Technology ETF (VGT -0.52%) — which contains 321 stocks from various areas of the tech industry — has earned an average annual return of 20.30% over the past 10 years. The Vanguard S&P 500 ETF (VOO -0.22%), on the other hand, has earned an average return of just 12.66% per year in the same timeframe.
Because there are so many industry-specific ETFs to choose from, it’s possible to invest as broadly or as narrowly as you’d like.
For instance, if you’re interested in general healthcare stocks, you could opt for the iShares Global Healthcare ETF (IXJ 0.20%). For a more specific fund, there’s the iShares U.S. Healthcare ETF (IYH 0.44%). Or if you’re looking to invest in a particular niche within the industry, you may choose the iShares Biotechnology ETF (IBB 1.21%) or the iShares U.S. Medical Devices ETF (IHI 0.16%).
Industry-specific ETFs can be a smart middle ground between individual stocks and broad-market funds like S&P 500 ETFs. They can be used to build a more customized portfolio and potentially earn above-average returns, yet they don’t require as much time or research as individual stocks.
One big risk to consider before you buy
Perhaps the biggest downside to industry-specific ETFs is that they carry more risk than broad-market funds that track a wide variety of sectors.
While ETFs can provide significant diversification compared to investing in individual stocks, all of the stocks within each of these ETFs are from the same sector. That increases your risk, especially if you’re investing in more volatile industries like tech.
For that reason, it’s wise to either invest in several industry-specific ETFs to broaden your portfolio, or to also invest in a broad-market fund that includes a wide variety of sectors. By avoiding relying on stocks from a single industry, you can further reduce your risk.
Investing in ETFs can be a simpler and more straightforward way to invest in the stock market, and industry-specific funds could supercharge your earnings with less effort than buying individual stocks. By building a diversified portfolio and investing wisely, you could earn more than you might think over time.
Katie Brockman has positions in Vanguard S&P 500 ETF and Vanguard World Fund-Vanguard Information Technology ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.