Industry and Sector Analysis: Finance

Estimated read time: 4 minutes

Consumers and investors have a love-hate relationship with the financial sector. As consumers, we often hate them. Banks gouge us with fees, open accounts without our knowledge, and then there is the small matter of the not so small part the sector played in collapsing the world economy in 2008.

But those who invest in the financial sector often love it because it's in the business of making money for investors.

If you're of two minds when it comes to the finance sector, our industry and sector analysis can give you some clarity.

Industry Outlook Summary

The financial sector includes banks, investment funds, insurance companies, and real estate. Performance of this sector is closely tied to interest rates. When interest rates are low, business in the financial sector tends to be good. A big source of revenue for the financial sector is mortgages and other types of loans. Of course, people borrow more money when rates are low.

The financial sector learned some hard lessons after the 2008 debacle, and there are some regulations in place meant to prevent a repeat performance. We have all learned the meaning of the phrase "Too big to fail" since 2008. We know the big players in the financial sector could repeat the same mistakes that led to 2008, and the government could step right in and bail them out again.

But the dust has settled. Practices were restructured, and while after 2008 a lot of regulations were forced upon the industry, new regulations are not likely in the current political climate, and some in place since 2008 are being rolled back.

While many of us might feel mistrustful of banks, we don't really have much choice but to use them. It may be possible to live your life cash only, but it's not practical. There aren't many of us, no matter how off the grid we may be regarding banking, who can afford to buy a home without a mortgage. So, like it or not, (consumers don't, investors do) banks, and therefore the financial sector, have us right where they want us.

External Influencers

While the financial sector thrives during periods of low interest when there are small increases in interest rates, that is typically beneficial. The rates haven't been hiked so high that consumers are not borrowing money, and at the higher rates lenders make more on the cash they hold and on the loans they make.

Consumers were badly spooked by 2008, and it drove people to decrease the amount of debt they had. This means fewer consumers defaulting on loans and filing for bankruptcy.

If the Fed hikes interest rates fast, people will stop buying houses, and because mortgages make up such a large portion of the financial sector, it will be felt. These trade and tariff fights that seem to crop up every few weeks are bad for the financial sector because they mean less demand for corporate loans and fewer mergers and acquisitions.

We want to hope that banks learned their lessons after 2008, but increased deregulation could make them reckless. Many in the industry felt the regulations were too stringent and have just been waiting for the rollbacks so they can play Wild West again. It may increase profits in the short term, but we all know the long-term consequences when the gunslingers have a clear field.

Technology and Associated Risk

Technology is a blessing and a curse to the financial sector as it is for many others. A blessing because technology has streamlined so many processes, and when something is sleeker, it's generally less expensive to run and maintain. If you want to refinance your student loan, you don't even have to speak to a bank employee, nevermind actually walk into a bank (the horror!). In fact, when is the last time you did have to go into a bank? You can thank technology for that.

No information, perhaps apart from that held in the healthcare sector, is more sensitive than that held by the financial sector. They have everything hackers love: Social Security numbers, dates of birth, passwords, mother's maiden names, bank and credit account numbers, PINs. All of it.

A hacker with more in mind than stealing some money could do untold damage to not only the financial sector and its customers but to entire economies and even governments. The sector does what it can to protect sensitive information, but it seems like no matter how good they are, the hackers are just a little better.

How to Invest in Finance

If you want to invest in the finance sector, there are two ways to do it: buy individual stocks or invest in an ETF.

Individual Stocks

This isn't for beginners. You'll need to open an account with an online investment company and know how to research companies in order to make a wise investment. Some of the big names in finance include the big banks we all know like Chase and Citibank, FinTech companies like PayPal and Guidewire Software, and private equity firms like KKR or Apollo Global Management (these are not endorsements).

ETFs

This is the best option for financial sector investing for those relatively new to the game. ETFs track the performance of the finance sector and give investors broad exposure to a "basket" of different stocks within that sector. Fidelity offers the MSCI Financials ETF and Vanguard offers Financials ETF.

Before You Leap

Many investors, Millenial investors in particular, some of whom were coming out of college around the time of the 2008 crisis, are understandably wary when it comes to the financial sector.

We've seen there is a fail-safe, the American taxpayer. The government is not going to let these big banks fail. If you're nervous, stick to the big banks. If you're really nervous, stick to ETFs. Either way, you have to stay invested long-term. Should another 2008 happen, many people will be looking to sell like their hair is on fire. That is a mistake. Investing is a long-term proposition.

If you look at investing overall that way, and investing in the financial sector, in particular, then there is room in everyone's portfolio for financial sector stocks.

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