Diversification, which can reduce investment risk and improve yield, is achieved by allocating assets among a variety of investment classes, such as stocks and bonds. Diversity can be further increased across investment subclasses.
Stock subclasses include company size, geographical region and market sector. Sectors are categories of stocks concentrated around a particular service, product or activity. Key sectors include financials, technology and energy. Performance can vary significantly from sector to sector, and rallies in one sector can help offset declines in another.
In the first quarter of 2011, for example, the energy sector led with returns of 16.8 percent, while the financials sector yielded 3 percent, according to a Market Insights report by J.P. Morgan Asset Management, but since the market low of 2009 the financials sector has yielded returns of 170.8 percent, while the energy sector has yielded returns of 97.9 percent. Yet, despite its robust recovery from market lows, the financials sector has yielded a negative 50.4 percent return since its market peak of 2007, while energy has had an 8.1 percent return since its peak.
Performance among sectors varies because economic, social and political events affect the sectors differently. The financial sector is made up primarily of lending institutions which thrive in times of economic growth. The technology sector is comprised of companies that develop and produce computers, software and other electronics. As exporters, these companies benefit from a falling dollar, which makes their products more competitive in overseas markets.
The Health Care sector covers companies relating to medical care and products. The sector is considered Recession-proof because it provides an essential service, but the industry took a beating in the last recession when a high percentage of unemployed workers lost their health care insurance and did not seek treatment.
The Materials Sector is comprised of companies that extract and process raw materials, such as steel or paper products. The sector is vulnerable to slowdowns in construction and manufacturing that reduces the demand for raw materials.
Investors who balance their stocks portfolios among diverse sectors can participate in sector highs and offset sector lows. Research by Spectrem Group shows that diversification and risk are top considerations for millionaire and non-millionaire investors.