[Podcast] DGB 08: Sector Allocation - How Many Sectors Should You Have in Your Portfolio and Which Ones?

Sector allocation is a key component in a good investment strategy. But how many should an investor hold? And which ones? If you follow Mike’s simple process, you will rapidly build your sector allocation and identify the ideal number of stocks to hold in each.

Master this concept now!

You’ll Learn

How many stocks should an investor have in his portfolio and why.
Which sectors to choose according to your risk tolerance.
Why one should not invest much more than 20% in a single sector.
How many stocks to hold and how many per sector.
What is sector rotation and should you use it.

Core, Growth or Income Sectors?

If you ever read any “investing 101” books, they will all tell you that your asset allocation is the prime determiner of your investment returns. The key is to hold some of the best companies from each industry sector. Here’s my view on how each sector can help you build a stress-free retirement portfolio.

Core sectors

Core sectors include companies you should consider first. It doesn’t mean they must all be in your portfolio, but they are are less likely to be impacted by a global recession. Each one has its unique characteristics.

Technology: Dividend growers in this sector are usually “old techs” that are dominant in their industry. They are sitting on significant cash and cash flows and are often ignored by retirees due to their low dividend yields.

Financial services: Banks are at the center of our capitalistic system. They can get too greedy (2008 anyone?), but in general, they offer a good source of dividends. Canadian banks are by far my favorites. You can also find great companies among large asset managers (BLK) and payment processors Visa (V) and Mastercard (MA). I’m less interested in life insurance companies as they must deal with this low interest rate environment we are in now and that complicates their portfolio management.

Consumer defensive: Classic and boring companies fly under the radar during economic booms, but they suddenly become market favorites during recessions. We all need to eat, brush our teeth and clean our house.

Healthcare: Healthcare businesses have one thing in common; no matter how the recession hits, our health remains crucial. Therefore, recessions should be less harsh on them.

Growth sectors

While you can find growing businesses in all sectors, some industries will offer you stronger growth potential. Many investors would consider the technology sector in this category, but I prefer to classify it as core assets.

Consumer cyclicals: The name says it all; when the economy booms, consumer cyclicals follow. This is a rare sector where you can go over 20% and still have wide diversification. The buying process for a new car isn’t the same as for a burger or a t-shirt.

Industrials: The second sector in the growth category is industrials. Like consumer cyclicals, the industrial sector offers a wide variety of sub-sectors that are not linked together. Since each industry follows a different cycle, you often have the chance to pick stocks at a cheap price while several clouds are gathering.

Income sectors

Ah! The section you have all been waiting for… the dream of all retirees: living off your dividends without touching your capital! This has become a difficult strategy to achieve as many high yielding stocks get crushed during recessions. Fortunately, there are some sectors offering a decent yield and some peace of mind.

REITs: The tax structure behind REITs is designed for the business to distribute the largest part of their profit to shareholders (unit holders). For many, Real Estate is the definition of stability in the investing world.

Utilities: Another haven for investors during crises are utilities. People need power and water. Utilities in general should be able to benefit from our current low interest rate environment. Don’t expect much growth as the economy slows down, but the dividends should remain safe.

Telecoms & communications: In the communication services sector, it will be hard to find companies with low debt levels that will generate consistently growing dividends. Go for the ones with a solid business model and strong cash flow.

Ignore those sectors

I will go straight to the point: I dislike the energy and basic materials sectors. The reason is quite simple: both sectors depend on commodity prices to be profitable. Since they have no control over those prices, their cash flow is often volatile. This situation makes them marginal dividend growers. I understand you can occasionally make a great investment in those sectors, but most people get burnt more than they get rich.

You’ll Learn