The U.S. economy is complex, and business performance can vary widely among different industries. Some industries tend to lead when the economy is growing rapidly, others shine during periods of slower growth, and still others outperform during periods of recession or recovery. Regardless of broader cycles, industries may respond differently to certain trends or specific events.
For this reason, spreading investments among major business sectors is one way to help diversify stock market holdings. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
If your portfolio includes one or more broad-based mutual funds, you already hold stocks of companies across a range of sectors. However, you may want to consider a more targeted approach.
The Right Weight for Your Portfolio
Stocks of companies included in the S&P 500 index have traditionally been categorized among 10 different business sectors, with each sector weighted based on market capitalization — the total value of outstanding stocks (see chart). Sector weightings may change with changing circumstances. For example, the weighting of the energy sector has fallen with declining oil prices, while the weighting of technology stocks has risen with higher tech profits.1 The S&P 500 is just one example of sector weighting, and the appropriate balance for your portfolio depends on your individual circumstances.
A sector fund focuses on stocks of companies in a particular industry or market sector. Because these funds are less diversified than broad-based funds, they typically carry a higher level of volatility and risk, and should be considered as a complement to a core portfolio of diversified mutual funds rather than as a replacement. Here are three ways you might use a sector fund.
- Fill an exposure gap or otherwise address an imbalance in your core holdings, which may become under- or overweighted in one or more sectors.
- Help moderate overall portfolio risk by investing in sectors that are historically less volatile or less economically sensitive than the stock market as a whole.
- Pursue higher returns over time by investing in sectors with greater potential for long-term growth. (Higher growth potential comes with higher risk, and you should be prepared to hold such investments for at least 5 to 10 years through a sector’s full cycle.)
Although sector funds offer flexibility in fine-tuning your portfolio, it’s important to resist the temptation to chase performance and move assets into "hot” sectors without a more comprehensive strategy. Sector performance is cyclical, and last year’s hot sector can easily turn cold. Also keep in mind that every business cycle is different, and unexpected events can disrupt regular trends.
The return and principal value of all investments, including sector funds, fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
1) S&P Dow Jones Indices, 2016