Investors who loaded up on tech stocks before the market crashed last fall learned a painful lesson: “Don’t put all your eggs in one basket.” Whether you’re an aggressive take-no-prisoners sort of investor or the mild-mannered, conservative type, everyone needs some diversification in his or her portfolio. You ought to build up several baskets of stocks in different industry sectors.
The universe of publicly traded companies is broad, with more than 36,000 stocks trading on the market. But there are hundreds of industry sectors, ranging from auto parts to books to restaurants to telecommunications services. There are even subsectors, such as pharmaceuticals within health, computers within technology, and footwear within retail.
Unless you can withstand the greatest level of risk both financially and psychologically, never concentrate exclusively on one sector. “Regardless of how strong a sector’s revenue growth and earnings may be, there’s no need to expose yourself to that kind of concentrated risk4short-term or long-term,” advises Dave Kansas, author of TheStreet.Com Guide to Smart Investing in the Internet Era (Doubleday, $24.95).
Steven L. Sanders, president and co-CEO of Philadelphia-based MDL Capital Management, a money-management firms, suggests you start with the sector within which you work. “If you work in retail, you know how much foot traffic there is; you can size up the mall; you can watch shoppers’ spending habits. This is great sector research,” he explains (see “Investing in What You Know,” July 2001).
Ideally, says Sanders, you want to pick the best company or two within your favorite sectors. Then determine what percentage of your portfolio you want in each sector.
HOW MANY STOCKS TO OWN?
Diversification doesn’t mean owning a lot of stocks. It means making sure your portfolio is balanced with stocks from across the industrial spectrum. “A portfolio of a dozen or so stocks should provide you with both the protection of diversification and the focus to build wealth in the market,” says Kansas.
The simplest way to invest in various sectors at one time is to own mutual funds. But for individual stock pickers, Kansas recommends you “choose a few stocks that are likely to produce above-average returns over the long haul, concentrate the bulk of your investments in those stocks, and have the fortitude to hold steady during any short-term market gyrations.”
TOOLS FOR SECTOR ANALYSIS
There are several resources to help you analyze sectors. StockCharts.com provides charts that show the performance of the S&P 500 by industry sectors. MarketGuide.com lists 102 industries sorted daily by performance. It also includes links to companies in each industry.
Once you determine which sectors interest you, it will be easier to locate the best performing companies in those sectors. Several Websites rank stocks within a given sector. Check out their financial screening tools, which will scan for stocks that meet your criteria. You can also screen for stocks using industry indexes, sector listings, and industry listings.
Compare your level of diversification to the sector composition of the Standard & Poor’s 1500 SuperComposite Index, a combination of the S&P 500, S&P Midcap 400, and the S&P