What is Sector? (Plain English Definition)
Definition: A sector is a broad grouping of companies that share similar business activities, such as technology, healthcare, energy, or financials.
Sector Explained Simply
Sectors are the standard categories used to classify companies by their primary business activity. The Global Industry Classification Standard (GICS) divides the stock market into 11 sectors: Information Technology, Health Care, Financials, Consumer Discretionary, Communication Services, Industrials, Consumer Staples, Energy, Utilities, Real Estate, and Materials.
Each sector responds differently to economic conditions. Technology and Consumer Discretionary tend to perform well during economic expansion. Utilities and Consumer Staples are defensive -- they hold up better during recessions because people keep paying electric bills and buying groceries regardless of economic conditions. Energy is tied to commodity prices. Financials benefit from rising interest rates.
Sector ETFs allow investors to target specific areas of the economy. Popular sector ETF families include the Select Sector SPDR ETFs (XLK for technology, XLF for financials, XLE for energy, etc.), Vanguard sector ETFs, and iShares sector ETFs. These funds provide concentrated exposure to a single sector, which means higher risk but the potential for higher returns if that sector outperforms.
Sector Example
During 2022, the Energy Select Sector SPDR ETF (XLE) gained 66% while the Technology Select Sector SPDR ETF (XLK) fell 28%. This 94 percentage point difference illustrates how dramatically sectors can diverge in any given year. An investor holding only a broad S&P 500 ETF would have earned the market-weighted average of all sectors, declining about 18% -- much better than tech but much worse than energy.
Why Sector Matters for ETF Investors
Sector awareness helps ETF investors understand what drives their portfolio's performance and make informed decisions about whether to overweight or underweight certain areas of the economy. When you own a broad market ETF, you already have exposure to all 11 sectors, weighted by market cap. For ETF investors, sector ETFs can be used tactically or for conviction-based investing. If you work in healthcare and understand the industry well, you might add a healthcare ETF to overweight that sector. However, sector concentration increases risk -- a single sector can underperform the market for years. Most financial advisors recommend keeping any individual sector tilt modest relative to your total portfolio.
Sector vs Diversification
| Sector | Diversification |
|---|---|
| A sector is a broad grouping of companies that share similar business activities, such as technology, healthcare, energy, or financials. | See full definition of Diversification |
While sector and diversification are related concepts, they serve different purposes in the world of ETF investing. Understanding both terms helps you make more informed decisions about which funds to include in your portfolio and how to evaluate their performance.
Related Terms
Deepen your understanding of ETF investing by exploring these related concepts:
Diversification
Diversification is the strategy of spreading investments across different assets to reduce risk, based on the principle of not putting all your eggs in one basket.
Overweight
Overweight means allocating a higher percentage of your portfolio to a particular security, sector, or asset class than its weight in the benchmark index.
Underweight
Underweight means allocating a lower percentage of your portfolio to a particular security, sector, or asset class than its weight in the benchmark index.
Asset Allocation
Asset allocation is the strategy of dividing your investment portfolio among different asset categories like stocks, bonds, and cash.
Holdings
Holdings are the individual securities -- stocks, bonds, or other assets -- that make up an ETF's portfolio.
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