Diversification Across Sectors
"Don't put all your eggs in one basket." Sector diversification is one of the most important risk management tools.
Why Diversify Across Sectors?
1. Reduce Concentration Risk
If you own only tech stocks:
- Tech crash = your whole portfolio crashes
- Sector rotation away from tech = you underperform
- One sector's problems become your problems
2. Smooth Returns
Different sectors perform well at different times:
- When tech struggles, utilities may shine
- When energy booms, healthcare may lag
- Diversification smooths the ride
3. Capture Opportunities
By owning multiple sectors:
- You participate in whatever's working
- You don't need to predict sector rotation
- Some holdings always have tailwinds
The Investment Garden
A garden with only tomatoes is vulnerable—one disease wipes everything out.
A diverse garden with tomatoes, peppers, lettuce, and herbs is resilient. If one crop fails, others survive.
Your portfolio should be a diverse garden, not a monoculture.
How Much Diversification?
Minimum Diversification
- At least 3-4 different sectors
- No single sector > 40% of portfolio
- Mix of cyclical and defensive
Moderate Diversification
- 5-7 different sectors
- No single sector > 25% of portfolio
- Balance across economic sensitivities
Full Diversification
- Exposure to all 11 sectors
- Weights similar to market (or intentional tilts)
- Comprehensive coverage
Key Takeaways
- Diversification reduces risk without sacrificing returns
- Own stocks across multiple sectors
- Balance cyclical and defensive sectors
- No single sector should dominate your portfolio
Sector Correlations
Some sectors move together, others don't:
High Correlation (Move Together)
- Technology ↔ Communication Services
- Financials ↔ Industrials
- Energy ↔ Materials
Low Correlation (Move Independently)
- Technology ↔ Utilities
- Healthcare ↔ Energy
- Consumer Staples ↔ Financials
For better diversification: Own sectors with low correlation to each other.
Building a Diversified Portfolio
Step 1: Assess Current Holdings
- What sectors do you own?
- What's the concentration?
- What's missing?
Step 2: Identify Gaps
- Which sectors are underweight?
- Which are overweight?
- What would improve balance?
Step 3: Find Candidates
- Use sector leaderboards
- Find top stocks in underweight sectors
- Apply your screening criteria
Step 4: Rebalance
- Add to underweight sectors
- Consider trimming overweight sectors
- Maintain target allocations
Sample Diversified Allocations
Conservative Portfolio
| Sector | Allocation |
|---|---|
| Healthcare | 15% |
| Consumer Staples | 15% |
| Utilities | 15% |
| Financials | 15% |
| Technology | 15% |
| Industrials | 10% |
| Other | 15% |
Growth Portfolio
| Sector | Allocation |
|---|---|
| Technology | 25% |
| Healthcare | 20% |
| Consumer Discretionary | 15% |
| Financials | 15% |
| Industrials | 10% |
| Other | 15% |
Balanced Portfolio
| Sector | Allocation |
|---|---|
| Technology | 20% |
| Healthcare | 15% |
| Financials | 15% |
| Consumer Staples | 10% |
| Consumer Discretionary | 10% |
| Industrials | 10% |
| Other | 20% |
Index Funds for Instant Diversification
If picking individual stocks across sectors feels overwhelming, consider:
- Total market index funds (instant diversification)
- Sector ETFs (easy sector exposure)
- Core + satellite approach (index core + individual picks)
Common Diversification Mistakes
1. False Diversification
Owning 10 tech stocks isn't diversified—it's concentrated in one sector.
2. Over-Diversification
Owning 100 stocks dilutes your best ideas. 15-30 stocks is usually enough.
3. Ignoring Correlations
Owning tech and communication services isn't much diversification—they're highly correlated.
4. Chasing Performance
Adding sectors just because they're hot leads to buying high.
Diversification Traps
- Thinking many stocks = diversification (sector matters)
- Over-concentrating in familiar sectors
- Ignoring defensive sectors in bull markets
- Panic-selling diversified holdings in downturns
Congratulations! You've completed Module 11. You now understand how sector context affects your investments and how to diversify effectively.
Next Module: Common Mistakes to Avoid—learning from others' errors.