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This screen capture shows the top 11 sectors year to date from Fidelity Investments. When investing, I am sure we all have a favorite sector we lean towards. For some, it is the information technology industry where rapid gains and losses are commonplace, whereas other people enjoy more stability with a higher dividend and often Consumer Staples or utility companies.
Today I am addressing the importance of having an allocation to some extent, to each of these industries in your portfolios, why one should have some exposure to each area and optimal ways of allocating one’s portfolio. Time and time again, I hear of people investing in their favorite companies and putting a lot on the line because of these biases. When people do this, they are trading with an emotional bias rather than logic and proven principles. First, I am going to run by a situation we just encountered in the past month, and why it is crucial to diversify across industries.
I have been invested in the Oil & Gas industry (-55.37%) or the Airline industry (-41.38%) the past couple of months, it has been beyond painful to watch. Due to the circumstances around our country right now, travel has severely been reduced and as a result, it is impacting airliner's bottom lines and profitability. Furthermore, I believe they may have more headwinds to face in the coming months because even if the situation is under control here in the U.S, I doubt international routes will open up significantly over the next year. These losses are sobering, and if you were overweight in these industries now is tough, but it is an important learning experience going forward on the criticality of diversification in one's portfolio.
Just by looking at this graph an individual might think, I am only going to invest in the Consumer Staples and Information technology going forward, because during a crisis they aren’t affected as significantly. While these sectors do hold up well when times are hard, hindsight is 2020, one could have never known this epidemic was going to happen last year. Furthermore, all sectors move up and down during periods of time. Sometimes financials will be up, and consumer staples will be down, likewise, sometimes Real Estate and Healthcare may both be up, significantly. While certain sectors and industries tend to move concurrently, a balance should be struck to the appropriate allocation percentages per each area.
My strong suggestion would be to just get started allocating across sectors. Simply start doing this, and I guarantee many people reading this are only allocated across ¾ sectors and they may not even know it. If you are invested in an index or mutual fund, you likely have exposure across all the sectors, but the investments just may not be intentional. Knowing there are 11 major sectors, simply allocate 9-10% of your portfolio to each sector.
When you get more advanced with your investments then try and look at how one sector influences another. It is certainly more of an art than a science but think about it in elementary terms. If people stop traveling through the airline and auto industry, what other sector would be directly impacted? The energy sector would be hit hard. Knowing this, maybe it would be best to allocate a smaller percentage of your portfolio to both of these sectors because they go hand in hand. If you are less risky but enjoy stable growth then put a larger allocation to Consumer Staples and utilities. Note, oftentimes returns may be smaller in these areas, and growth may take a while, but you will have a stable and relatively predictable stream.
Being a successful investor is all about reducing unnecessary risks in your portfolio, and it is extremely difficult to reduce risks if you aren’t allocating across sectors and industries optimally. While finding your optimal allocation may take time, getting in the practice of spreading your investments across sectors will help alleviate one, especially in a time like now. In this crazy world, we never know what may happen. A war may break out, an oil spill may happen, natural disasters may damage a countries livelihood, or a virus-like we are seeing now may sweep the world. Being diversified across several sectors will provide one with the assurance they need that all of their eggs aren’t in one basket.