Learn what role the different investment sectors play in helping you build a diversified portfolio by testing your knowledge with this quiz

One key part of our three-part investing program is to diversify by spreading your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities. (The other two parts are to invest mainly in well-established, dividend-paying stocks and avoid or downplay stocks in the broker/media limelight.)

Test your knowledge below on how to diversify your money across different investment sectors for maximum gain.

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A. Diversifying your portfolio holdings across the different investment sectors…

1. Cuts the risk of your holdings
2. Improves your chances of making money
3. Works to protect your portfolio whatever happens in the market
4. All of the above

You are correct if you answered 4.

Diversifying your stocks across all five sectors is more than just a safeguard. It will significantly improve your chances of making money.

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

As part of their portfolio diversification strategy, 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.

B. Conservative investors may want to emphasize which of these different investment sectors?

1. Resource sector investments
2. Utilities and Canadian banks
3. Manufacturing sector investments
4. None of the above

You are correct if you answered 2.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks in their portfolio diversification, because of these stocks’ high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks.

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.

C. You may have to decide if a company falls into a consumer or manufacturing sector by…

1. Looking at how it is classified
2. Considering how the market classifies it
3. Making a judgment call
4. It does not matter what sector it falls into

You are correct if you answered 3.

Deciding if a company falls into the consumer or manufacturing sector is partly a judgment call. A manufacturer of soap or soup would be in the consumer sector because these goods get bought and consumed every day. A car maker belongs in manufacturing because consumers can hold off on buying a new car for years.

Consumer products, for instance, are non-cyclical. They benefit from continuous, habitual use and have steady sales regardless of the economy.

D. Which of the different investment sectors can offer a hedge against inflation?

1. Resource
2. Consumer
3. Utilities
4. None of the above

You are correct if you answered 1.

The resource sector is subject to wide and unpredictable swings in the prices it gets for its products. In the rising phase of the business cycle, when business is booming, resource demand expands faster than resource supply, so resource prices shoot up. This balloons profits at resource companies. When the economy slumps, resource prices fall, and this drags down resource profits and stock prices.

In addition to rising and falling with the business cycle however, resource stocks also have a history of rising along with long-term inflationary trends. This gives them a rare ability: they provide a hedge against inflation.

E. True or False: Each of the five economic sectors we recommend investing in can fit into the framework of the 11 broad Global Industry Classification Standard (GICS) sectors.

You are correct if you answered “True.”

There are many approaches to classifying and choosing investments, and new ones come along all the time. I understand the five sectors approach was common in the early part of the 20th century. It was already on its way out when I first heard about it in the early 1970s.

The problem is that as the economy changes, the five-sectors system forces users to make judgment calls. Many people who run major investment institutions and stock exchanges prefer a system that doesn’t allow for judgment calls, much less demand them. That makes it simpler to judge the performance and determine the appropriate pay grades for the hundreds of analysts and fund managers who work for these institutions.

My goal is different. I stick with the five-sectors approach because I see it as a better tool for managing investments and balancing risk. This has nothing to do with being old-fashioned or stuck in a rut. I just haven’t come across anything better.

Most stocks fit easily into one of the five sectors—Manufacturing & Industry, Resources & Commodities, Consumer, Finance, and Utilities. However, there are exceptions. More generally, we assign the industries as follows:

• Energy & Materials = Resources
• Industrials = Manufacturing
• Consumer Staples = Consumer
• Consumer Discretionary = Manufacturing
• Health Care = Consumer or Manufacturing
• Financials = Finance
• Technology = Manufacturing
• Communication Services = Utilities
• Real Estate = Manufacturing

Is there an economic sector you favor while investing? What has led you to this?

Which economic sector do you feel gives you the most secure investment options?