Eric Reed* says indexing sections of your portfolio to specific industries can be a good way to capture gains in the stock market.
What industries should you invest in?
That is literally the million-dollar question.
Professional investors dedicate their careers to it.
Figuring out where the money will move is a big deal.
Of course, that doesn’t mean it’s hopeless to try to identify strong investment industries for your own portfolio.
But it does mean you should take any advice on this subject with a grain of salt.
Here are three tips to consider when figuring out the best industries to invest in.
First: Keep a consistent strategy
One of the biggest mistakes that retail investors (like you and me) make is active portfolio management.
We try to play the market, timing stocks and moving money around to chase the latest hot sector.
This usually results in losses, and the investors who don’t lose money generally make less than they would have with a little bit of patience.
There’s nothing wrong with setting aside a pool of money for speculation, but the bulk of your portfolio should be built around a strategy.
You invest around goals; balance growth against your capacity to rebuild after losses; maintain a healthy diversity of assets and industries; and plan to hold most investments for a period of years.
Smart investors focus on long-term growth and buy securities for the real value of an underlying asset.
Don’t ask what the market will do with this stock next month, ask whether the company selling it has a sound business model.
And don’t disrupt that in search of the next hot thing.
When looking for the best industries to invest in, start by focusing on your strategy.
Second: Invest in sector-indexed funds
When you want to invest in a specific industry, the best way to do so is through what’s known as a “sector fund”.
Sector funds are a form of index fund, a portfolio of assets built so that its total growth mirrors a third-party benchmark.
For example, an S&P 500 index fund would be built out of a bundle of assets so that the portfolio overall tracks the growth and losses of the S&P 500.
You can invest in these either through mutual funds or exchange traded funds, each with their own set of rules and processes.
Many funds are indexed to specific industries.
These are called sector funds.
These products are built to track the performance of specific industries.
For example, a financial sector fund might try to track the gains and losses of the banking and lending industry overall, while a technology sector fund would try to reflect the performance of tech companies.
Sector funds require more analysis than typical index funds because there’s no unambiguous benchmark for the fund to track.
In the case of something like the S&P 500 or the Dow Jones Industrial Average, the fund can use an existing number to judge how accurately it has performed.
There is no universal benchmark that measures any specific industrial sector, though, so these funds are put together based on the given fund managers’ best judgement.
As a result, you should make sure to study the past performance of any given fund before investing.
Third: Choose an industry
We saved picking the actual best industry to invest in for last.
Why is that?
It is because we absolutely cannot overemphasise the importance of fundamentals.
The best advice we can give you as an investor is to manage your money for the long run.
A well-diversified portfolio built with an eye toward underlying asset value over a period of years will serve you far better than one that tries to maximise stock tips.
Based on what you want your portfolio to do, some sectors will suit you better than others.
Here are some examples.
Growth investors: Technology
There’s no other way to say it, technology is the growth sector right now.
The biggest gains often cluster around high-tech products, and firms like Apple, Google and Facebook have become world-striding firms with more cash than many sovereign governments.
As a result these firms tend to post fast gains, which can be very good for growth-oriented portfolios.
Be careful, though.
Growth comes with risk.
Already the market has begun to show signs of trouble ahead for this sector as the unicorns of the digital startup space have struggled to convert their enormous market success into actual profits.
Stability investors: Consumer staples
Consumer staples are the basics like food, clothing and products we all use on a daily basis.
This sector lives by the age-old rule that when it comes to money, boring is good.
The underlying demand for these products doesn’t tend to change much with financial conditions, so this is historically one of the most stable sectors you can invest in.
It won’t deliver explosive growth, but it’s unlikely to surprise you either.
Economy investors: Consumer discretionary
Many investors build their portfolio around the performance of the stock market overall.
To do this, they invest heavily in market-index stocks that track indices like the S&P 500 and the Dow Jones Industrial Average.
You can extend this strategy to investing in the economy overall, trying to index your portfolio to the general growth of the economy.
The consumer discretionary sector is a good investment choice for investors who would like to do this.
Like consumer staples, this industry represents consumer spending, but unlike its counterpart, it focuses on the products that people don’t need such as entertainment, luxury goods and consumer electronics.
Low-risk investors: Health care
The healthcare sector generally reflects companies such as those that produce medicine and medical devices and privately traded medical services providers.
This tends to be a highly stable sector because the demand for health care has no relationship to the economy at large.
People need health care at a steady, stable rate that will only grow as the population at large continues to grow.
This is not an industry for big gains, but it is one for someone who wants to minimise risk.
* Eric Reed is a freelance journalist who specialises in economics.
This article first appeared at www.thestreet.com.