I just came across this David Rolfe interview about common investment mistakes people make with stock portfolios. You can watch it, I’ll wait. Then we can talk about it after.
Rolfe’s advice is pretty simple, but it speaks to a consideration that tens of thousands of investors never ponder. In short, if you have a portfolio of 30 stocks, and six of them are stocks from a single sector, you aren’t truly diversified. Instead, you are betting 20% of your entire portfolio on the performance of a single sector. If that sector experiences a correction, you’re going to be hurting.
— GuruFocus PodCast (@gurufocuscast) September 12, 2016
Sector Funds in Summer 2017
The Rolfe interview is a year old, before we had experienced the meteoric rise of a number of tech stocks that are still roaring along at the time of this writing. I’m sure that a number of my readers hold these stocks and have enjoyed incredible returns this year.
However, it’s important to look at your portfolio critically and reasonably at our portfolios. It’s common advice among value investors that a portfolio of 30 stocks is truly diversified. But the reality is that a portfolio over reliant upon the performance of a single sector is deeply vulnerable.
I’ve written recently about how likely it is that we’ll experience a market correction in the next year or two. Quick update for those who have not been reading along:
- We are in the third largest market expansion in American history.
- Consumer debt is approaching or exceeding 2007 levels.
- Certain significant Hype stocks have prices that have nothing to do with their underlying value.
- Housing prices are soaring in significant markets.
- Donald Trump (reasons too diverse to name)
David Rolfe himself has a stock portfolio of 37 companies. But you (if you are willing to pay through the paywall) can see the diversity inherent in these allocations. In the event of a market correction, losses will be dispersed among companies that will lose big and others that experience only secondary losses.
What Should You Do If You Accidentally Have a Sector Fund?
If you find yourself with a sector fund, you can 1) keep it because that’s what you want, 2) sell off some excess holdings and diversify, or 3) sell it all, take your gains, and find somewhere else to put your money. I would recommend something in the #2 range of behaviors.
Guessing on sectors requires perfect foresight if you want to make money in the long term. 2017 has been a year when investors in big name stocks basically cannot fail. But (And this goes out especially to young investors) this climate will not last forever.
On the other hand, there is nothing you can do to completely shelter your money. In many ways, even index funds have become sector funds, as holdings become ever more representative of the current tech revolution (bubble?) we’re currently experiencing.
Now would not be a bad time to consider real estate, bonds (even though you won’t see big growth in this current market), or even cash. At the very least, avoid putting all your eggs in one sector basket. If you’ve enjoyed big gains, consider locking them in and spreading yourself out a little more thoroughly.