What are the stock sectors? It’s an essential question for learning how to diversify your portfolio.
What are the stock sectors, and how many of them are there? That depends on where you get your information. Some sources say there are 11 stock sectors. Others list five, while another source may suggest there are 10 stock sectors. Let’s break this down a little, figure out why it’s important, and then get into what the stock sectors are.
But first, a story about a chivalrous fellow named Don Quixote. Initially published in two parts (1605 and 1615) by Miguel de Cervantes, Don Quixote is part fantasy, part social critique, and quite possibly the first modern novel ever written. The book is famed, in part, for its many proverbs and maxims, some of which are rather humorous.
One proverb, however, has come down through the centuries, and is so well-known that you can find it on everything from folk art to inspirational posters. The original version, translated from Spanish, reads, “It is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.” This is otherwise known as, don’t put all your eggs in one basket. The literal embodiment of this is that if you put all of your eggs in one basket, and you drop the basket, you’ve lost all your eggs. Put them in several baskets (or sectors if we’re talking about stocks), and if you drop a basket, you will lose an egg, but you’ll still have some to take home for dinner.
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What are the stock sectors, and what does that have to do with eggs?
Here’s how this applies to stock sectors. More precisely, here’s how it applies to stock sectors and diversification. Many investors pay no attention to diversification. Instead, they find a sector or industry they like and invest their entire portfolios in one place. That’s great if all of those stocks just keep going up. But the laws of nature—and the stock market—never work that way for long. Consequently, those investors eventually lose their shirts because even the very best sectors don’t rule the market forever.
The bottom line is this: By adequately diversifying your portfolio, you reduce the risk that all of your assets will decrease in value simultaneously. But “adequately diversifying” doesn’t mean just scattering your money around the market willy nilly.
In fact, while some investors ignore diversification, many take it to an extreme, investing only in broad index funds because they believe it’s impossible to beat the market. Others buy so many stocks that their portfolios begin to resemble index funds. But the more your portfolio starts to look like the broad market, the closer your returns will be to average. That’s fine if you’re happy matching the indexes, but not if you want to be above average.
In other words, even though diversification will help you limit risk by offsetting losing positions with winning positions, the opposite is also true—losses will offset gains and reduce returns.
So diversify, but not too much. Now, what are the stock sectors where your money is going? The Global Industry Classification Standard (GICS) is a classification system that divides the economy into 11 sectors. This system is used by thousands of market participants, and almost every financial advisor, broker, and so on uses this system.
What are the stock sectors, according to the GICS?
1. Energy. This includes oil and gas, like Exxon Mobil (XOM). Energy stocks are not widely owned, and therefore even the best ones are exceedingly undervalued.
2. Utilities. Utility stocks are known for being low risk—they’re often called “widow and orphan stocks” because they’re appropriate for just about any investor. Utilities deliver slow but steady growth, and take advantage of that predictability to pass much of their cash through to investors as regular dividends. The average utility stock yields about 3%. Like consumer staples companies, utilities have very reliable revenues because the demand for water and power doesn’t change much even when the economy slows down.
3. Materials. The Materials sector encompasses numerous industries, such as chemicals, construction materials, and paper products. DuPont (DD) is a good example here.
4. Industrials. The Industrials sector covers major transportation stocks, aerospace, and electrical equipment. This includes companies such as Boeing (BA).
5. Consumer Discretionary. This sector consists of retails stores, automobiles, hotels, and restaurants. In other words, those things we like to buy, but we don’t necessarily need to buy.
6. Consumer Staples. Consumer staples are things like groceries, personal care products, and household items that people tend to buy regardless of economic conditions. The sector includes many high-quality blue-chip stocks, like Procter & Gamble (PG) and Colgate Palmolive (CL).
7. Healthcare. The Healthcare sector is relatively straightforward. It includes pharmaceuticals, life sciences, and healthcare providers.
8. Financials. Again, this sector is pretty clear cut: banks, mortgage brokers, and real estate investment trusts (REITs). Interestingly, insurance companies fall into this category, too.
9. Information Technology. Here you have computer and software companies, tech hardware, and electronic equipment.
10. Communication Services. This sector includes wireless communication companies, as well as media and entertainment providers.
11. Real Estate. Aside from the expected real estate management businesses, this sector also includes equity real estate investment trusts, which is a little different than the REITs in the Financials sector. Gotta keep you on your toes, right?
As you can imagine, some sectors are more volatile than others. And some seem to have quite a bit of crossover. Still, thinking carefully about where your money is going will help you shape your investment portfolio in a way that best suits your needs.
What are the financial sectors that you prefer to invest in?