One way to help control risk and increase your portfolio’s chances for a healthy return is through diversifying your investments across and within the major asset classes. Holding a mix of large, mid, and small cap stocks and investment grade bonds of varying maturities can be a good start toward reducing your portfolio’s volatility. But you don’t have to stop there. You can further moderate risk by investing in different sectors of the economy.
A market sector is an area of the economy that includes companies or industries offering the same or related products or services. Market sector classifications vary and include areas such as energy, health care, and information technology, among others. There are ten market sectors in the Standard and Poor’s 500.
Investing across various market sectors can help diversify a portfolio. Certain industries may be more affected by economic events than others. Cyclical stocks tend to be influenced by and sensitive to how the economy behaves. Demand for products and services in industries such as housing, transportation, financial, and technology declines when the economy slows, so stock prices may stagnate or fall. However, cyclical stocks have the potential for significant gains when the economy is thriving.
On the other side are defensive stocks. They’re from industries where consumer demand tends to remain stable, even in a slow economy. They include utilities, food, oil, and other staples. Since demand for these products stays relatively constant, defensive stock prices typically don’t rise dramatically when the economy is strong. Including a mix of cyclical and defensive stocks from a variety of market sectors can help diversify your portfolio.
Different investment styles, such as growth and value, typically offer different sector exposures as well. So selecting a mix of investment styles for your portfolio may offer further diversification by providing a balance of industries that respond differently to different economic conditions.
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