INVEST PRIMER–BALANCING YOUR PORTFOLIO (EQUITIES)

Balance in an investment portfolio reduces the volatility.  I believe that the perfect analogy would be the pistons in your car’s engine, which move through the Up and Down cycles on an alternating basis.  A one-cylinder lawnmower, on the other hand, makes a lot of noise and vibrates considerably, because there is no counter-balance to reduce the volatility of that one piston.  Now, consider how you would feel if all of the securities in your retirement nest egg went Up one day, and Down the next.

Balance reduces that short-term volatility and it allows you to focus more on the long-term performance. There should be stocks, bonds and some cash in your portfolio, and gradually the percentage of each should be modified, over time, to be more conservative as you grow older, and approach retirement.  Cash, although not an investment, per se, helps accommodate additions to, and withdrawals from, your portfolio.

Generally, various market factors cause stocks and bonds to rise and fall at different times.  Also, the same can be said about some stocks moving in opposite directions, one from another, as well.  For now, however, I will just present the basic stock considerations in a balanced portfolio.  Also, don’t forget to monitor your various investment pockets (r account) combined, rather than as individual portfolios.

There are numerous stock indices, but the Dow Jones Industrial Index (of 30 stocks) is undoubtedly the best-known.  The Standard and Poor’s 500 Index, however, tends to be more representative of the overall stock market.  Just like a Presidential poll, the more people that you ask, the greater the accuracy. Therefore, the S & P Index (of 500 stocks) is what most market professionals use when tracking the stock market.

The S & P is sub-divided into ten “industrial sectors”, or Industries. The weighting (or statistical importance) of any one stock is in accordance with their respective market values.  For instance, Apple, Inc, the largest company in market value, represents 3.96% of the overall index, while Pfizer, Inc. represents just 1.13% of it.  The actual market capitalization of Apple and Pfizer are $729.375 billion and $217.674 billion, respectively.  The slight differences that occur in the relative weightings of each of the 500 components, that can drift out of alignment, are re-configured every quarter to reconcile them with the (then) current market values.

The percentage of each of the industrial sectors is generally a good guide in order for an investor to compare their investment performance with the S & P 500, which is sometimes referred to as the “broader stock index”.  Obviously, there are many more components, such as small companies and global stocks, in the overall stock market.  Next, let’s look at the market value weighings of the various industrial sectors.

Within the overall S & P 500 Index, this is the percentage of all stocks within the various industries:

Consumer Discretionary     13.10%         (Non-necessities)
Consumer Staples                9.70            (Necessities)
Energy                                  7.20
Financials                            16.90
Health Care                         15.50
Industrials                              9.80
Information Technology         19.90
Materials                                2.90  (chemicals, mining, packaging, forest products, etc.)
Telecom Services                   2.20
Utilities                                   2.90

Some securities firms may provide guidance as to which industries they recommend investing more or less than the percentage represented in the S & P 500.  Generally, however, they will stay within a percent or two.  Keep in mind, however, that the firms will usually recommend weighting a portfolio reasonably in line with the Index; but, that is probably due to not wanting to assume the legal responsibility–in case they are wrong.  You are obviously free to invest more or less in any company or industry, as you choose.

Although I could go in several more directions regarding the configuration of the stock portion of your portfolio, for now; however, let’s continue to just stay with the basics.

NOTE:  For the next IBC blog post, I will discuss the various components of the bond market.  Unlike stocks, however, investors rarely try to use more than one or two types of bonds, or bond funds.

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