Sector Investing for Portfolio Balance
Stock investors often classify stocks by the type of business in which the company engages. By grouping like companies in this way, investors are able to more easily make comparisons when analyzing potential stock investments. The most common segmenting identifies a stock as either defensive or cyclical and further segments companies based on business type. Developing a basic understanding of the various stock sectors and their relationship to the business cycle can be helpful to those investors looking to build a balanced portfolio.
Defensive Stocks
Utilities and companies that provide consumer staples are seen as defensive stocks. These stocks do not typically suffer as much as other companies during economic downturns because demand for their products and services continues, regardless of market conditions. While defensive stocks are seen as providing stability (and often, income) to a portfolio, they usually do not appreciate in good and improving economic conditions the way cyclical stocks do.
Cyclical Stocks
Cyclical stocks are issued by companies that are more heavily influenced by economic conditions. While these stocks tend to perform well in good economic times, they may carry more downside risk when market conditions worsen.
Sectors that are considered cyclical include:
Basic materials: Companies involved with discovery, development and processing of raw materials
Consumer cyclical: Includes those companies that provide consumer good whose demand increases in a healthy economy (e.g. automobiles)
Technology: Companies that engage in the development and/or the distribution of technology-based products or services (e.g. software companies)
Healthcare: Refers to those companies that provide medical and other healthcare-related goods and services (e.g. HMOs or biotech companies)
Financial: Companies that provide any type of financial service to businesses or individuals
Energy: Those companies that produce or supply energy (e.g. oil companies)
Sector Investing and Portfolio Diversification
Because each sector offers unique characteristics to investors, selecting stocks or other securities from multiple sectors can help investors build a diversified portfolio. Some sectors perform better than others in different phases of the business cycle, so investing in a variety of sectors can help minimize risk and bring stability to a portfolio.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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