We know that the stock market is classified based on market capitalization and the type of sector. The different sectors in the stock market are Financials, Utilities, Consumer Discretionary, Consumer Staples, Energy, Healthcare, Industrials, Technology, Telecom, Materials, and Real State. Having these categories, it gets easier to identify stock which is one of the most heavyweight sectors is the financial sector. Going forward, we shall discuss the financial sector in detail.
What is the Financial Sector?
As the name suggests, the financial sector is a sector in the stock market, which composed of firms and institutions that provide services in finance to commercial and retail customers. The sector comprises of commercial banks, non-financial banking companies, insurance companies, co-operative banks, small financial entities, pension funds, mutual funds, investment companies, and real estate firms. All of these come under the umbrella of the financial sector.
This is an essential sector in the market as it determines the economy of a nation. If the financial sector is performing well in the market, so will the economy as well. Contrarily, if the financial sector is of a country is weak; it means that the economy is also weakening.
Why does the economy of a nation depend on the Financial Sector?
Let us break it down and understand why both of these go hand in hand. The financial sector includes the companies which provide loans to businesses and startup so that they can expand in their domain, they grant mortgages to landlords and also provides insurance policies to people and companies to keep them well-protected. Worth a mention, it also offers savings and investment plans to the people who are unaware of what to do with their savings. Most importantly, it provides employment to millions of people. All of this is possible only if the financial sector does well. Therefore, if the financial sector does well, it will be able to ensure all the above facilities are satisfied, and hence, the economy tends to grow. The financial sector generates its revenues from loans and mortgages. This results in the interest rates to drop. When the interest rates are low, there is incoming capital and investment, which improves the economic growth of a country.
The Financial Sector in the US
The most significant portion of the S&P 500 is made up of the financial sector. Some of the largest financial companies in this sector include JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, etc. There are several other companies, as well. However, the companies mentioned above are the most dominating ones in the sector. Also, the insurance industry, which comes within the financial sector, is the second largest industry within. For example, the American International group and Chubb are one of the largest insurance companies in the US.
What are the factors that affect the Financial Sector?
Some factors affect the financial sector, both positively and negatively. The following are some of the decisive factors that affect the sector.
1. Increase in the Interest Rate: As the interest rates increase moderately, the financial companies start to earn more amount of money as they issue loans to people with interest rates on them.
2. Reduced regulation: When the government decides to decrease the management on the financial companies, the financials are benefitted by it and also reduces the burden on them.
While the negative factors include:
1. A rapid rise in interest rates: The increase in the interest rates at a swift pace, could lead to a lesser demand for loans and mortgages, which leads to a negative effect on the financial sector. Therefore, only a moderate rise in interest rates can show good growth in the financial sector.
2. Increased regulation: When the government starts to regulate the financial sector, it could lead to an adverse impact on the financials. However, this could perhaps help to protect the consumers, but, would bring down the business of the financial companies.
Why should you consider investing in the Financial Sector?
Many investors consider having at least one financial sector stock in their portfolio. We know that the economy and the financial sector correlated with each other. Hence, in developing countries, if the economy is growing at a good pace, then an investor can consider investing in this sector, hoping that it will do it will perform well in the long term. Most of the banking sector companies often pay a dividend to their investors. This is another reason that attracts people to invest in this sector.
Risks involved in investing in the financial/banking sector
Just like any other sector in the stock market, the financial sector has risks involved. Some of the risks factors in the financial sector are:
1. Rising NPA’s: The increase in NPA in the sector is a key concern to the companies. If a payment of the loan is overdue for more than 90 days, it is termed as a Non-Performing Asset (NPA). If the NPA is high, it means that there is a significant amount of loan payment that is overdue. Due to this, the banks will be cautious when it comes to distributing loans. Therefore, the investors must be careful before investing in these companies and must ensure that the NPA is on the lower side.
2. Increased competition: Talking about the developing countries, the government is granting new licenses to open new banks. This heats the competition among the banks. To attract consumers to their banks, the banks come up with schemes or funds. This means that the banks will be feeding on each other’s market share. Therefore, this limits the banks to outperform. Hence, investors find no point over investing in banking stocks.
The bottom line on investing in the Financial Sector
Well, there no loss as such in having a financial stock in your portfolio. However, your portfolio must be diverse. In other words, one must not overbuy the financial stocks or any other sector stocks for that matter. According to financial experts, investing in the financial sector is an excellent idea only if you have a long term sight. If you have a long term perspective, investing mainly in the banking sector can be the right choice. And, if you have a short-term investment plan, you can invest in an NBFC (Non-Banking Financial Company) and meet your financial objectives.