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One of the key factors of a generally healthy investment portfolio is diversification or, in other words, ensuring you aren't putting all of your eggs in one basket, financially speaking. A diverse portfolio can help protect investors from significant losses if a single company or sector you're invested in faces a major downturn. If you put all your life savings in Apple stock and the company suddenly goes under, for an extreme example, you'd be in rough shape. But if your investments are spread out across Apple, Walmart, Johnson & Johnson and various other companies, you can generally decrease risk in your portfolio because it's less likely they'd all have a downturn at the same time. That begs the question: Why would investors be interested in an investment fund that's focused on a single sector? Themed exchange-traded funds are ETFs tied to a specific industry like artificial intelligence or space exploration, or more broadly on a theme like natural resources or infrastructure. Investors, especially younger adults, are increasingly adding these kinds of funds into their portfolios. "A thematic ETF can be a great complement to those existing [diversification] strategies because it allows investors to, for a lack of better phrase, double-click or increase their exposure to an investment theme," says Todd Rosenbluth, head of research and editorial at investment research firm TMX VettaFi. These funds are "often investing in companies that are smaller in size and more targeted in their exposure to a particular theme." Investors poured roughly $95 billion into themed ETFs in 2020 and 2021, according to a new Morningstar analysis. Many investors then retreated from the funds from 2022 through 2024, but have since returned — net inflows to themed ETFs totaled $76 billion since Dec. 2024, the analysis found. Perhaps unsurprisingly, AI-themed ETFs are leading the charge, with investments in the industry making up nearly a third of those inflows, per Morningstar. "I think people have confidence in the longer-term [AI] trend," Rosenbluth says. Themed ETFs are especially resonating with Gen Z investors. The youngest adult generation was the most likely to say thematic ETFs were of interest in Nasdaq's 2024 Retail ETF Investor survey. Some 75% of Gen Z investors (those born between 1997 and 2021) held ETFs in their retirement accounts, the survey found, and 34% of Gen Z investors said they're interested in thematic funds. The survey polled 2,000 retail ETF investors in March 2024 with a margin of error of plus or minus 2 percentage points. "[Younger investors] are more comfortable with ETFs than older investors, because mutual funds are less prevalent and relevant than they were for their parents' generation," Rosenbluth says. "The younger generation are more likely to and appropriately take on some risk through the equity marketplace and have more time for these strategies to take hold." Here are a few tips he says Gen Z investors and anyone interested in thematic ETFs should consider. 1. Diversify your themes While you could technically build a diversified portfolio through several different ETFs with the same theme that hold different companies, it's wise to get invested in a variety of themes to give your portfolio broader exposure. "You can benefit from that by having an all-encompassing artificial intelligence theme," Rosenbluth says. "But if and when spending slows down for artificial intelligence, that's going to negatively impact related ETFs." Tech and AI stocks have generally performed well in the last few years and have at times been the driving force behind the market's record highs. But they're not the only industries that can deliver solid returns for investors. "There are sectors outside technology that are doing very well and could do very well, and so there's the benefit of diversification," he says. Utilities, space exploration and infrastructure-themed ETFs could be of interest, he adds. 2. Make sure themed ETFs complement your portfolio If you're looking for a good themed ETF to invest in, Rosenbluth adds that it should complement your portfolio, not just give you more exposure to the large-cap stocks you may already own. This can easily happen if you broadly invest in indexes like the S&P 500 or Nasdaq-100. Take advantage of the fact that ETFs disclose their holdings daily to see the various stocks you're getting, Rosenbluth says. "It's good when you don't recognize all of the stocks that are within the top 10 of a portfolio," he says. "Assuming that you're trusting that the ETF provider, the index provider that's behind it, is doing the right thing, it's a good thing that you're not getting Apple and Microsoft within your thematic ETF, because you're getting up-and-coming companies that can potentially benefit [you]." 3. Do your research Along with looking into the companies an ETF is holding, Rosenbluth encourages investors to look into the ETF provider as well and make sure you "like the way they're doing things." Look at the fee structure of the ETF, whether it's actively or passively managed and analyst ratings that can reveal the efficiency of an ETF in terms of its performance, cost and other factors.
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