As stock and bond markets reel from a litany of concerns including oil prices, inflation and the economy, a well-designed strategy of diversification within an investment portfolio might help ease some otherwise sleepless nights for investors.
One goal of diversification is to lessen the likelihood of substantial losses while still providing the opportunity for attractive longer-term rates of return. This is done by owning securities that are not perfectly correlated with each other. In other words, their values may move in different directions at different times. During the past year, for example, gold and other commodity prices have moved higher while stocks have generally moved lower.
One method of diversifying a stock portfolio is to invest in companies within different industry groups or sectors. For this purpose, it is helpful to look at a broad measure of stocks, such as the Standard & Poor's 500 Index. The S&P 500 is comprised of the stocks of 500 widely-held companies and is often used to measure the performance of the U.S. stock market.
Stocks in the index are selected by a committee at Standard & Poor's. Each stock's weighting in the index is proportionate to its market capitalization or value, which is typically calculated by multiplying the number of shares of stock outstanding by the current price per share. At mid-June, the largest position was Exxon Mobil Corp., representing approximately 4 percent of the index. This was followed by shares of General Electric, Microsoft, AT&T and Chevron Corp.
The stocks within the S&P 500 are categorized into 10 broad sectors or industry groups with numerous sub-groups. It is interesting to observe the changes that have occurred in the sector weightings in the past year. For example, in June 2007 the largest sector was the financials group including banks, insurance companies and brokerage firms, representing 21 percent of the index. Energy was the fifth-largest sector, weighing in at 10.7 percent.
Currently, the sectors are weighted within the index as follows: technology (16.4 percent); energy (16.2 percent); financials (14.2 percent); health care (11.9 percent); industrials (11.2 percent); consumer staples (10.8 percent); consumer discretionary (8.1 percent); utilities (4 percent); materials (3.9 percent) and telecommunications (3.3 percent).
By owning stocks across several of the major industry groups, an investor can lower the volatility or risk of a stock portfolio. At any point in time, however, there may be some securities moving lower in value while others are moving higher. It may become tempting to sell the securities moving lower and buy more of whatever is moving higher. By doing so, however, the diversification within the portfolio could be destroyed, leaving the investor with a highly focused group of securities instead. While this may work fine for a while, it could ultimately end in disaster as happened with technology stocks and, more recently, real estate.
Daniel Chappie is with Peninsula Asset Management, Inc. in Bradenton. He can be reached at (941) 748-8680. or DanielC@PeninsulaAsset.com.
INVESTING
Daniel Chappie x
E-Mail
Print
@Nyx.CommentBody@