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Finance is an integral part of our daily lives. Making purchases on credit or debit cards, paying bills electronically, and getting mortgages or other loans are normal aspects of the way we live. New technology is disrupting finance along with every other segment of society. With that disruption comes opportunity: investing in financial stocks.
The financial sector makes up a significant portion of the S&P 500, the market index making up roughly 500 companies listed on U.S. stock exchanges. As part of a balanced stock portfolio, investing in financial stocks could make sense.
Read on to find out more about financial stocks, how to invest in them, and when investing in financial stocks makes sense.
What Are Financial Stocks?
Financial stocks refer to companies involved in the financial sector. These run the gamut, and financial stocks may include:
- Asset management firms
- Banks, both commercial and retail
- Consumer finance providers
- Insurance companies
- Investment brokerage firms
- Real estate investment trusts
- Savings and loans
How to Invest in Financial Stocks
As with any security, you can perform your research and purchase suitable financial stocks through your online brokerage or a good robo advisor. Here are some other ways you can invest in financial stocks.
Mutual funds specializing in the financial sector are another alternative. Top-ranked financial mutual funds include:
- Fidelity Select Brokerage and Investment Management Portfolio (FSLBX): Since its inception in 1985, this fund has returned an average of 12% with an expense ratio of 0.76%. Top holdings include Morgan Stanley, Blackrock Inc., Charles Schwab Corp. and Intercontinental Exchange, Inc. T. Rowe Price.
- Financial Services Fund (PRISX): Top holdings include Bank of America, Wells Fargo, Chubb and American International Group. Its five-year average return is 9.75%, while the expense ratio is 0.89%.
- Fidelity Advisor Financial Services (FAFDX): This fund includes Wells Fargo, Citigroup, Bank of America and Morgan Stanley. It’s been around since 1996 and its five-year average is 8.23%. Its expense ratio is 1.09%.
You can also invest in financial stocks through exchange traded funds (ETFs). Some of the top financial ETFs include:
- SPDR S&P Regional Banking ETF (KRE): This ETF focuses on regional banks and includes First Republic Bank, Comerica Incorporated, KeyCorp and Citizens Financial Group. The average three-year total return of this ETF is 5.59%. The gross expense ratio is 0.35%.
- Invesco KBW Bank ETF (KBWB): Also offering exposure to regional banks, this ETF invests a minimum of 90% of total assets in the securities of publicly-traded U.S. regional banking and thrift companies. Consisting of roughly 50 regular holdings, no individual institution accounts for the majority of assets. Its three-year average total return is 9.74% and the gross expense ratio is 0.35%.
- Vanguard Financials ETF (VFH): Institutional giant Vanguard is well-known for its low fees. Its financials ETF has an expense ratio of just 0.1%. Meanwhile, the three-year average total return is 12.32%. The largest holdings include JPMorgan Chase, Berkshire Hathaway, Bank of America and Wells Fargo.
Another option for investors in the financial sector is putting together a personal stock portfolio based on top mutual fund and ETF holdings. Since fees are so critical to your total return, compare the costs of brokerage fees with fund expense ratios.
Are Financial Stocks a Good Investment?
By nature, financial stocks are always vulnerable to current financial conditions. Interest rates affect financial stocks, positively or negatively. For instance, rising interest rates can boost banks, insurance companies and similar stocks because higher rates can mean higher profit margins. Rising interest rates also indicate a growing economy, as a healthy economy corresponds to lower levels of loan defaults. Banks also benefit from the difference between the rates paid to customers for products such as certificates of deposits and the amount earned on treasury bills and other high-rated debt.
One caveat is that a bank’s stock value relates directly to the quality of its loans. Without knowledge of a bank’s loan approval and default rates, it is difficult to accurately assess the risk factors of a particular investment. You can check out the bank’s accounting reserve, the amount the bank must have on hand to ensure it can meet unexpected loan defaults. A large reserve means the bank can cover such losses without overly affecting its earnings report.
With the proliferation of online banking, many brick-and-mortar banks are closing branches, selling the related real estate and cutting operating costs. This branch reduction can bode well when it comes to increasing earnings by share.
Best Financial Stocks to Invest in
Whether you should invest in financial stocks depends on your personal investing portfolio and investing style. If you’re unsure about what to invest in, we recommend talking to a financial advisor like Paladin. Otherwise, take a look at some of the companies listed below and see if they would be a good fit for your portfolio.
We are not recommending any of the stocks listed, but just providing them as a starting point for you to do your own research before talking to your financial advisor.
Value Financial Stocks
Value investors seek stocks they believe are currently underestimated. The best value financial stocks include:
- S&P Global (SPGI): One of the world’s largest ratings agencies, S&P Global not only rates bonds, stocks and commodities, but also provides data and analytics for investment professionals and governments. It has long been a steady and somewhat underrated performer. Over the past five years, its stock price has risen 270%.
- Lincoln National Corp. (LNC): This company operates insurance and investment management businesses through subsidiaries. It offers annuities, life insurance, retirement plans and group protection. Analysts at Morgan Stanley recently increased its target price.
- Virtu Financial Inc. (VIRT): A large provider of financial services and marketmaker services, Virtu Financial helps create more efficient markets by providing deep liquidity for more than 25,000 securities and 235 venues in 36 countries. Last year, it posted record results, but its valuation has not increased, making it a good value pick.
Fastest Growing Financial Stocks
Some of the fastest growing financial stocks include:
- Ally Financial (ALLY): Over the past three years, Ally Financials’ earnings per share has grown by 39% annually. This company has a big presence in the auto loan market, and global car sales are projected to grow substantially this year and next. Mortgage lending and insurance are also primary strengths. It has long been considered one of the leading online banks.
- Goldman Sachs Group Inc. (GS): The earnings per share of this venerable and major financial institution rose 118.29% in the 12 months ending March 31, 2021, while its net revenue in the first quarter of 2021 was $17.70 billion.
- Regions Financial Corporation (RF): One of the country’s full-service consumer and commercial banking providers, Regions banks are located in the South and Midwest. In the first quarter of 2021, it made a 18% increase in pretax profit, and reported $614 million in net income.
Banks make up the bulk of the financial sector. Banking stocks fall into three categories: commercial, retail, and investment. Some banks, known as universal banks, have retail and investment components. Among these are some of the largest banks, internationally and U.S. based, such as:
- Bank of America
- Credit Suisse
- Deutsche Bank
- ING Bank
- Wells Fargo
Banking stocks to consider in 2021 include:
- First Republic Bank (FRC): This bank and its subsidiaries offer private banking, business banking and wealth management. It operates in New York, California, Florida and other major markets, with 70% of its portfolio involving residential real estate loans. In the first quarter of 2021, revenue grew 23.8%.
- JP Morgan Chase (JPM): By assets, JP Morgan Chase is the largest U.S. bank. It is also the most profitable. For all its size and diversity — its revenue comes from commercial, consumer, and investment banking, as well as wealth management — it is undervalued relative to its position. The company has announced plans to invest $12.5 billion in technology infrastructure as digital banking exploded during the pandemic.
- US Bancorp (USB): The seventh-largest U.S. bank is an excellent choice for dividend investors. For more than a decade, its dividend has exceeded that of the average bank yield and that of the S&P 500. Branches are concentrated in the Midwest and West. It also owns Elavon, a credit card payment processing service for merchants.
Bank Stock Considerations
Keep in mind that banks are in the lending business, which means they are extremely leveraged. A bank’s business model is straightforward: it borrows funds at X interest rate from its depositors. Those funds are then lent to creditors at a higher rate.
Assessing a bank stock involves determining how it can minimize losses should the economy head south. Too many bad loans on the books — those at least 90 days overdue — jeopardize a bank’s future. The nonperforming loan ratio should never exceed 2%.
Once a debt goes unpaid for six months or more, the bank will likely issue a charge-off. As the lender, the bank realizes it is unlikely to collect the debt. Unsecured credit card debt is especially vulnerable to charge-offs; every bank has a provision for credit losses, or PCL.
Much depends on the type of business conducted by a bank. For example, banks focusing on credit cards produce a higher net interest margin. Credit card or business loan lending rates are higher, but come with additional risk. As such, you can expect a higher rate of charge-offs. Banks specializing in real estate or other secured assets have lower interest rates and thus a lower net interest margin. They generally experience fewer charge-offs due to the secured nature of the assets.
When investigating bank stocks, you should look at metrics such as a return on equity of at least 10%, a return on assets of at least 1% and its price-to-book value. The latter shows how much the bank trades for relative to its assets’ net value.
Bottom Line: Why You Should Invest in the Financial Sector
The financial sector is a critical part of a well-rounded portfolio. While often more volatile than other sectors, there is an advantage in financial investing in that most investors have a personal familiarity with the products and thus less of a learning curve. In fact, financial stocks are one of the biggest assets owned by impact investors.
The financial sector is part of our daily lives. And with new technologies and increasing wealth, financial companies are likely to be here for a very long time.