Things to Consider Before Investing in the Health Care Sector

As one of the largest sectors in the U.S. economy, health care is likely to be a part of many investors' portfolios. Investing in this sector can offer plenty of opportunities. It encompasses a wide range of businesses, from pharmaceutical companies to medical device manufacturers. Investors must also consider regulatory changes, technological developments and demographic trends when evaluating this sector.

If you want to invest in the health care sector, a financial advisor can help you create a plan.

Sub-Sectors Within the Health Care Sector

Health care is a major player in the U.S. economy. Spending in the sector in 2022 amounted to $4.5 trillion, or $13,493 per person, which is equal to 17.3% of U.S. gross domestic product, according to the Centers for Medicare and Medicaid Services . Spending on health care that year expanded by 4.1% and the sector is on a long-term trend toward increased spending that is expected to continue.

Before you invest, you should note that there are different sub-sectors within the industry. Each presents specific opportunities and challenges, and may or may not be suitable depending on your personal financial situation, goals and risk tolerance. Here are four major health care business sectors:

• Pharmaceuticals focuses on the development, production, and marketing of drugs and medications. Drug makers, in particular, can make lots of money. A study reported in 2020 in the Journal of the American Medical Association found large pharmaceutical firms had nearly twice the profit margins of big firms in other fields. At the same time, however, 90% of new drugs fail to get regulatory approval . The cost of developing a single new drug, meanwhile, can range from $1 billion to $2 billion . Investors should be aware of these potential hurdles as well as the potential for financial gain.
• Biotechnology includes companies that use living organisms or biological systems to develop products and technologies including treatments for diseases. The sub-sector offers high growth potential but is highly speculative. Biotech firms have failure rates similar to new drugs, at about 90% . Investors should consider the stage of development of the companies they are investing in, as well as the likelihood of regulatory approval and market adoption of their products.
• Medical devices include companies that design, manufacture and sell equipment used in medical procedures, such as surgical instruments, diagnostic machines and implants. This sub-sector can offer both strong and steady growth due to the ongoing need for medical equipment and the potential for disruptive new technologies. However, like pharmaceuticals and biotech, it's subject to regulatory scrutiny and competition from still newer technologies. Investors should evaluate the innovation pipeline and market demand for the devices produced by these companies.
• Health care services encompasses businesses that provide medical care and related services, such as hospitals, clinics and health insurance providers. Health care services investments can help stabilize an investment portfolio due to the constant demand for medical care. Still, external factors including changes in government policy, insurance reimbursement rates and the overall economy make long-term forecasts difficult. Investors should assess the financial health and operational efficiency of companies in this sub-sector.

Other Things to Consider Before Investing in Health Care

Beyond choosing a sub-sector, you should also consider these five general things before investing:

• Regulatory environment : The health care sector is heavily regulated. Government agencies such as the FDA can approve or reject new drugs, devices and treatments and with a single move devastate a company's strategy. Investors should be aware of the regulatory landscape and how it can impact the companies they are considering. Delays or rejections in regulatory approval can lead to significant financial losses.
• Technological innovation : Health care is a rapidly evolving industry, with continuous advancements in technology shaping the market. Investors should consider the potential for technological disruption, as well as the ability of companies to innovate and adapt to new developments. Companies that fail to keep up with technological trends may struggle to remain competitive.
• Demographic trends : The aging population in many parts of the world is driving increased demand for health care services and products. Investors should consider demographic trends when evaluating health care investments, as companies that cater to the needs of an aging population may offer more stable growth prospects.
• Economic conditions : The performance of the health care sector can be influenced by broader economic conditions. While health care is often seen as a defensive sector, economic downturns can still impact areas such as elective procedures and health care spending. Investors should assess how economic conditions might affect the companies they are interested in.
• Company fundamentals : As with any investment, it's important to analyze the fundamentals of the companies within the health care sector. This includes reviewing financial statements , management teams, competitive positioning and growth prospects. Strong company fundamentals can help mitigate some risks of investing in health care.

How to Invest in the Health Care Sector

Directly investing in individual stocks can allow you to target specific companies within the sector. This approach offers the potential for high returns, but also comes with significant risk, especially if the chosen companies face regulatory challenges or fail to bring products to market.

Another option is to invest in health care mutual funds or exchange-traded funds (ETFs) , which pool investments from multiple investors to purchase a broad range of health care stocks, reducing the risk associated with investing in individual companies.

You should note that mutual funds are often actively managed , with a fund manager making decisions about which stocks to buy and sell, while ETFs typically track an index and are passively managed. Both options allow investors to benefit from the overall growth of the health care sector while minimizing the impact of any single company's performance.

Investors can also consider health care-focused real estate investment trusts (REITs) , which invest in properties such as hospitals, nursing homes and medical office buildings. Health care REITs provide a way to invest in the real estate side of the health care sector, offering potential income through dividends and the possibility of capital appreciation. However, as with any REIT, performance can be influenced by factors such as interest rates and real estate market conditions.

Bottom Line

The health care sector is large and diverse, with opportunities for profit and significant risk. While demand for health care remains strong, the industry faces disruptive technologies and strict regulations, making it unpredictable for investors. Before investing, consider the sub-sectors, regulatory environment, technological changes and company fundamentals.

Tips for Investing

• A financial advisor can help you analyze investments and manage your portfolio. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• If your investment in health care, or any other sector, has increased in value, SmartAsset's capital gains tax calculator can tell you how much you're likely to owe in taxes if you sell it at a profit.

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