Financial Sector

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What is the 'Financial Sector'

The financial sector is a category of stocks containing firms that provide financial services to commercial and retail customers; this sector includes banks, investment funds, insurance companies and real estate. Financial services perform best in low interest rate environments. A large portion of this sector generates revenue from mortgages and loans, which gain value as interest rates drop.

BREAKING DOWN 'Financial Sector'

When the business cycle is in an upswing, the financial sector benefits from additional investments. Improved economic conditions usually lead to more capital projects and increased personal investing. New projects require financing, which usually leads to a larger number of loans.

The financial sector is one of the largest portions of the S&P 500. The largest companies within the financial sector are some of the most recognizable banking institutions in the world such as JPMorgan Chase & Co., Wells Fargo & Company, Bank of America Corporation and Citigroup Inc. Along with banks, the financial sector also consists of insurance, REITs, capital markets, consumer finance, financial services and mortgage finance. The second largest industry within the sector is insurance companies such as American International Group and Chubb Limited.

Why Invest in the Financial Sector?

Financial stocks are very popular investments to own within a portfolio. Most companies within the sector issue dividends and are judged on the overall strength of their financial health. In the financial crisis of 2008, the financial sector was one of the hardest hit with companies such as Lehman Brothers filing for bankruptcy. After an influx of government regulation and restructuring, the financial sector is considerably stronger in 2016. Economists often tie the overall health of the economy with the health of the financial sector. If financial companies are weak, this is a detriment to the average consumer. Financial companies provide loans for businesses, mortgages to homeowners and insurance to consumers. If these activities are restricted, it stunts growth in both small business and real estate.

Over the last 10 years, the sector has produced a negative 1.00% overall return for investors for the period ending May 31, 2016. This was caused by the financial crisis that produced catastrophic returns in 2007, down 18.63%, and 2008, down 55.32%. However, over the last five years, the sector has rebounded, giving investors an annual average return of 10.55%. This slightly underperforms the total S&P 500, which has a total return of 11.06% for the same time period. Investors looking for a sector bouncing back from a crisis and successful in a low interest rate environment should consider the financial sector.

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