When we speak of the stock market we describe it with the term “The Stock Market”, as if it’s a single, unified market.
The reality is nothing close.
The stock market is really a group of sub-markets, many of them very different from the rest. These sub-markets are commonly described as “sectors” and there are quite literally dozens of them.
Since sectors perform differently in various market conditions, it’s worth using them to your advantage in building your portfolio.
Common Market Sectors
As I said there are dozens of sectors—maybe even hundreds. But here are some of the more common ones.
These are stocks that generally pay little or no dividends, preferring to retain income to invest in growth. They’re usually newer companies in fast growing industries or markets, and perform very well in bull markets.
These are generally more mature companies that pay above average dividends and do so consistently. They usually also have a consistent history of increasing their dividends.
These are the stocks of otherwise strong companies whose stock is at depressed levels due to poor recent performance, industry factors or just plain bad luck. The idea is to buy them while they’re depressed and ride them up when they turn.
Small-, Medium- and Marge-Cap
This is three different sectors determined by the size of the companies, or more particularly their market capitalization (market value of outstanding stock).
The exact definition of small, medium and large is somewhat subjective. Small might mean stocks with a market cap of less than $1 billion, medium might mean $1 billion to $10 billion, and large might be anything larger. There’s some indication that the size of a company’s market capitalization affects it’s performance. The market size can even be broken out into categories like micro, etc… but these are the basic three.
Companies engaged in the production and distribution of electricity, water and natural gas tend to have relatively stable performance. They provide necessary services and usually pay high dividends.
These are companies involved in the production and distribution of energy, such as oil and gas companies. Since energy prices tend to be volatile, energy stocks could be a good choice for a buy low/sell high strategy. Timing is everything with this sector.
This sector mainly relates to gold mining companies, but with mutual funds and ETF’s it often includes holdings of the metal itself.
This is probably the most volatile sector, languishing most of the time, but providing spectacular returns when gold is in a bull market. Mining company stocks don’t always follow gold prices to higher ground though, making this sector nearly schizophrenic.
This is a catch phrase for a variety of technology stocks, including information technology, bio technology and others. Since this is a field that tends to define forward progress for the entire economy, it’s a sector that you never want be out of, especially when the economy is coming out of a recession.
This is a broad category as well, including everything from manufacturers of medical equipment, to hospital management companies to pharmaceutical companies. Since the healthcare industry grows no matter what else is happening with the general economy, it’s a sector you want to be in.
Banks, brokerage firms, mortgage companies and anything related, this sector is a play on the financial economy.
Diversifying among sectors, not just among stocks
Most investors understand the importance of diversifying, at least as it relates to individual stocks.
But it’s at least as important to diversify between sectors too.
At any given time, some sectors are rising, some are falling and some are running in place. By spreading your investment capital you not only minimize the impact of a falling sector or two, but you also position yourself to take advantage of one that’s taking off.
Some sectors, such as growth and dividend stocks, tend to be mutually exclusive to a large extent. Growth stocks are more volatile, rocketing in bull markets but crashing in bear markets. But dividend stocks tend to rise more slowly in bull markets, but fall less dramatically in bear markets. Having both is a way to participate in growth, while limiting the negative affect of a fall out.
Using mutual funds and ETF’s to build a portfolio
Unless you’re a big time investor with a seven figure investment portfolio, it will be difficult to diversify between the various market sectors, then to also diversify in individual stocks within each sector.
That’s where mutual funds and ETF’s come to the rescue.
There are hundreds of different funds that invest in the various sectors of the market, making it easy to buy into a virtual portfolio of stocks in any sector you want. No load and low load funds make this less expensive than buying individual stocks and you also have the benefit of professional management by an expert in each sector.
The last point is especially important; while you might be able to become an expert in one, two, maybe three sectors, you probably won’t be able to master several, at least not enough to do so profitably (and that’s if you’re lucky enough to really be an expert in the sector).
If you use funds to diversify into the different sectors, your job will be limited to deciding when to buy, when to sell and how much to invest in each. The more tedious work of deciding which stocks to invest in will be handled by your funds managers.
This has a major advantage to you as an investor. Were you to invest in every sector imaginable, you’d basically diversify yourself into the general market; you could do that with an index fund. But if you spend your time studying a group of sectors, you could become familiar with their cycles, what external factors affect them, and eventually, discipline yourself to buy in when a sector is cheap and sell when it gets too pricey.
You could do that because you’d no longer be tracking stocks, but stock market sectors. That’s an easier job if only because there are a lot fewer sectors than there are stocks. That can only increase your chance of investment success.
You can see there are a good number of basic headings a stock could fall under, and any particular stock could be in more than one market sector. Knowing about the commonly used sectors can help you diversify your portfolio for a better return as well as give you a way to study the market without trying to learn about every single stock. These days it’s easy to follow a sector with a mutual fund or ETF.
Knowing what these sectors are is another aspect of knowing what the market is and will help you in better understanding your investments.