The right sector weighting is key to a successful investing strategy

One of our key rules for successful investing is to diversify — spread your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities.

So you can get a sense of how you can put this investing strategy to work on your portfolio, I’d like to share an Inner Circle member’s question about sector weighting, along with our response. I hope you enjoy and profit from it.

Q: I have followed your investing strategy of spreading investments out across the five main sectors of the economy (Manufacturing & Industry; Resources; Consumer; Finance; Utilities) for many years now, and it has served me well.

Could you give some more guidance as to how much of my portfolio should be devoted to each sector? I realize that there is no hard and fast investing strategy for this, and I usually put new buying into whatever sector that I consider low in my portfolio, which raises the question of what is low?

Also, please provide an example of how a middle-aged investor might allocate $100,000 in a model conservative portfolio, along with any other investing strategy you have to offer. Thanks.

A: Speaking very generally, stocks in the Resources and Manufacturing & Industry sectors expose you to above-average volatility, and stocks in the Utilities and Canadian Finance sectors entail below-average volatility. Profits of Canadian Finance and Utilities firms tend to be more stable than profits of Resources or Manufacturing companies.

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Consumer stocks fall in the middle, between the highly volatile Resources and Manufacturing companies and the more stable Finance and Utilities companies.

Most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks for their high and generally secure dividends. More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks. For example, more aggressive investors could consider holding as much as, say, 25% to 30% of their portfolios in Resources. However, you’ll want to spread your Resource holdings out among oil and gas, metals and other Resources stocks for diversification and exposure to a number of areas.

Avoid basing your investing strategy on sector rotation

So-called “sector rotators” try to predict which sectors will outperform other sectors. But trying to pick winning sectors — and staying out of other sectors — seldom works over long periods. That’s because you need to guess right three times to succeed. You have to pick the top sectors, then pick the stocks that will rise within those sectors, then sell before the sector stumbles. It’s virtually impossible to consistently succeed at all three over long periods.

Model portfolios overlook individual investors’ goals

In response to the second part of your question, there are a number of problems with recommending a model portfolio for a large number of investors. The main one is that each investor has different goals, risk tolerance and so on. For example, as mentioned above, conservative or income-seeking investors may want to emphasize utilities and banks for their high and generally secure dividends. More aggressive investors might want to add more Resources or Manufacturing stocks to their portfolios.

As well, any model portfolio would need to be continually monitored and updated as individual stocks rise and fall in value and as a percentage of the total.

Different investors may be more comfortable holding a larger or smaller number of investments, including stocks, mutual funds or exchange-traded funds, in their portfolios, so you’d need to be careful in setting any specific number of investments in a model portfolio.

If you have questions about investing strategy, or if you’d like to ask me about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.