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Wednesday, November 27, 2024

5 Ways to Diversify your Portfolio by Sector

By Century Financial in 'Blog'

5 Ways to Diversify your Portfolio by Sector
5 Ways to Diversify your Portfolio by Sector
 

Imagine building a team for a football match – you wouldn’t want all your players to be strikers.

Similarly, sector diversification ensures that you do not rely too heavily on one area of the market when building an investment portfolio.

In this guide, we will discuss five points on effectively diversifying your portfolio by sector while keeping your wealth creation goals intact.

1. Look for Sectors with Little to No Correlation

 

Not all sectors behave the same. Some tend to move together, while others are entirely independent. For example, retail and consumer goods sectors often rise and fall in unison – so investing in both won’t reduce your risk significantly.

Instead, aim to invest in less correlated sectors. Think of pharmaceuticals, agriculture, energy, and finance. These sectors typically react differently to economic events, helping to balance out any volatility.

Read our blog How to Look for Sectors with Little to No Correlation to learn how to find low-correlation sectors.

2. Don't Overlook Major Sectors

 

Investors sometimes shy away from major sectors, thinking they’ve already reached their peak. But skipping these sectors can leave you exposed.

Banking, finance, technology, pharmaceuticals, FMCG (Fast-Moving Consumer Goods), energy, and agriculture are crucial economic drivers.

By including these heavy weights in your portfolio, you’re not just diversifying but also ensuring your portfolio aligns with the economy’s growth engines.

You can create a watchlist in the Century Trader App in order to keep a track of the movement of the asset classes you have on your radar.

3. Apply the 5 Percent Rule for Sub-Sector Investments

 

Each sector often has multiple subsectors. Take energy, for example—it includes oil and gas, solar, wind, and hydroelectric energy. While it’s good to diversify within a sector, overexposure to one subsector can hurt your returns.

Follow the 5 Percent Rule

Avoid investing more than 5% of your total capital in any sub-sector. This way, you spread your bets evenly and protect yourself from sharp downturns within any niche area.

4. Mirror Major Indices for Easy

 

Looking for a shortcut? Take cues from the sector distribution of popular market indices. For instance, look at the the S&P 500 allocation:

 
Top 10 Sectors in the S&P 500 by Weight
Information Technology 32.40%
Financials 12.59%
Health Care 12.21%
Consumer Discretionary 10.20%
Communications Services 8.67%
Industrials 7.49%
Consumer Staples 6.11%
Energy 3.32%
Utilities 2.61%
Real Estate 2.44%
Source: Investopedia
Date: October 1, 2024
 

By adopting a similar allocation strategy, you’ll not only diversify your portfolio but also align it with broader market trends. This method offers a benchmark to help guide your investments while giving you a shot at replicating the index’s performance.

5. Balance Cyclical and Defensive Sectors

 

Some sectors are cyclical – meaning they flourish during economic booms but struggle during downturns. Think about automobiles, travel, and construction. On the other hand, defensive sectors like healthcare, utilities, and consumer staples hold steady even when the economy slows.

A well-diversified portfolio strikes the right balance between the two. Cyclical sectors provide opportunities for growth, while defensive sectors act as a buffer during volatile times. With the right mix, you get both growth potential and stability.

Conclusion: Diversify Beyond Sectors for Complete Protection

 

Sector diversification is a smart way to reduce risk, but it’s only one part of the puzzle. For comprehensive protection, diversify across multiple asset classes – such as stocks, bonds, real estate, and commodities.

Think of your portfolio like a well-rounded sports team – sector diversification ensures each "player" (or sector) has a role to play. But remember, the key to long-term success lies in adaptability. As the market evolves, keep revisiting and rebalancing your investments to stay on top.

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