How to Create a Sector-Balanced Portfolio

Last Reviewed and Updated by Gabe Ross on November 26th, 2023

A central principal for successful investment is constructing a diversified portfolio. A well-diversified portfolio can earn better returns over time and remain resilient during market turmoil.

You can construct a diversified portfolio in multiple ways, including by selecting stocks from a diverse set of sectors and industries.

The idea behind sector diversification is that it can be dangerous to put all your money in one place. This is because market conditions do not affect all economic sectors the same way. If you have invested in only one sector, your portfolio can record huge gains when the sector rises, though you can also suffer steep losses when its fortunes reverse.

Spreading investments across multiple sectors can bring more stability to your portfolio. Experts advise building your portfolio with stocks that cover at least seven sectors. In a sector-balanced portfolio, losses from declining sectors can be offset by profit from the rising ones.

What Are the Best Sectors to Invest In?

Stocks are grouped into 11 sectors, with each sector holding stocks with similar characteristics.

Financial goals and risk tolerance are the factors that tend to influence investors’ sector selections. While you may like some sectors more than others, you should avoid the temptation of concentrating investments in only a few sectors and instead strive for balance in your portfolio.

Here are some of the major sectors of the stock market and their characteristics:

Financial Sector Stocks

This is where you have bank and insurance companies. The financial sector is highly sensitive to economic conditions, and banks can make more profit on loans when interest rates are rising. Insurance companies historical performance is also tied to interest rates, with profits generally increasing in periods of rising rates and decreasing when they drop.

Utility Sector Stocks

This is where you find water and electricity companies. The utility sector is regarded as one of the most stable segments of the economy. Regardless of economic conditions, households need to keep the lights on and the water running. There is always demand for utilities, in all economic conditions.

Utility stocks can also be a great source of stable and high-yield dividends. As a result, many investors turn to utilities as a defensive strategy during a recession. However, the sector is characterized by slow growth.

Consumer Staples Sector Stocks

This sector houses companies that make a range of products that households need ranging from food to toiletries. These products tend to see stable demand because they are necessary for the normal functioning of households.

You can also find stable, high-yielding dividend stocks in this sector. As a result, the Consumer Staples sector is another source investors go to for defensive stocks during tough economic times.

Information Technology Sector Stocks

Information Technology is the largest sector of the stock market in terms of market capitalization. It comprises companies that provide software, hardware, and an array of technology-driven services. For growth stocks, the IT sector is one of the best places to look.

Healthcare Sector Stocks

This is another broad sector. It consists of companies that develop drugs, provide supplies for laboratory diagnosis, and produce medical devices and equipment. This group also includes companies that offer treatment services, such as hospitals. Healthcare insurers also belong to this sector.

Healthcare businesses also tend to be stable, because economic conditions have little impact on demand for medical services. As a result, healthcare is another favorite sector to go for defensive stocks during economic turmoil.

Industrial Goods Sector Stocks

The Industrial Goods sector consists of companies that provide capital goods, such as factory machines and construction equipment. Aircraft manufacturers and defense companies also belong to this group.

This sector tends to be sensitive to economic conditions. It can boom during times of economic expansion, and struggle in times of economic belt-tightening.

Basic Materials Sector Stocks

This sector consists of companies that provide materials that go into making other products. Here you will find mining companies, suppliers of industrial chemicals, and providers of product packaging materials.

The performance of Materials companies tends to be sensitive to economic conditions. As a result, Materials stocks can exhibit elevated volatility in tough economic times.

What Is the Best Sector Allocation Strategy?

Just as financial goals, risk tolerance, and capital availability are unique to every investor, sector allocation strategies also vary by individual or institution.

If you are just getting started to build a sector-balanced portfolio, you may struggle to find a suitable strategy. The easy way of learning to sector diversify is following the allocation of an index fund. An S&P 500 index fund (SPX) can be a great guide toward building the best sector-balanced portfolio. You may begin by following the allocation strategies of such funds. As you gain more experience, you can adjust your allocation to be more in tune with your preferences.

Sector volatility is an important factor to consider when structuring portfolio allocations. As some sectors are more volatile than others, you should make your sector allocation decisions with your risk tolerance in mind.

How to Create a Sector-Balanced Portfolio – Summary

If you’re investing for the long-term, you can’t ignore sector diversification in your portfolio. A sector-balanced portfolio can provide some insurance against risks in tumultuous market conditions.

In sector diversification, avoid the temptation of buying too heavily into sectors that you prefer. Instead, you should be guided by your financial goals and risk appetite when selecting sectors for your portfolio.

On TipRanks, you can view Wall Street experts’ most recommended stocks by sector and see stocks with strong potential to beat the market. Moreover, you can screen stocks by dividend yield, price target upside potential, and hedge fund interest.

Creating a sector-balanced portfolio requires a lot of work. However, this is an important investing strategy that you can’t afford to overlook. TipRanks provides investment research tools and insights that can help create a well-diversified portfolio.

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