Rathbun: Pay attention to the sectorsWritten by Gary Rathbun | | GaryRathbun@PrivateWealthConsultants.com
There is more to investing in the large capitalization sector than just putting money in the S&P 500. We do a lot of portfolio audits in our office and more often than not we see the large cap allocation simply put into the S&P 500 as one investment. While there are times with this is probably the correct thing to do, if an account is below $250,000 or so, there is a better method to investing in the S&P.
The S&P index is made up of 10 different sectors. Each sector is divided out by the percentage of the weighting of the different companies in that sector. For example, the technology companies in the S&P add up to 19 percent of the entire index.
On any given day some of the sectors will go up and some of them will go down. If we knew which ones, it would be easy to invest in the ones going up and not invest or short the ones going down. But since we don’t know which sectors are going to move in which direction a simple strategy is to invest in all of them, but invest separately and in the percentage weighting of the index.
In this “break out” strategy you would invest in all 10 of the sectors, using Exchange-Traded Funds (ETFs) with the weighting of the index. So my large cap allocation would consist of 19 percent in technology, 16 percent in financials, 12 percent in health care and so on.
What this strategy does is allow you to participate in the sectors that are moving up and limit your exposure to the sectors going down.
This strategy cannot be done with small amounts of money in a portfolio. You have to have enough size to make it worthwhile since there are an increased number of transactions and complexity. It is also very important to make sure that you hedge each position consistently to protect the downside. If you do not hedge each position, it makes little sense to use this technique since your results will not vary too much from simply buying the index in one holding.
To add an additional element of potential return to the portfolio, you can go one step further and look at the different companies that make up the sector and diversify a little more by picking up some of those names as well.
Once again look at the technology sector: Apple, Microsoft, IBM and Google are in the top holdings and they are good companies. Part of your 19 percent allocation in the technology sector could also include some shares of each of the top companies in that sector. This also has the potential to increase returns as well as the potential to decrease returns.
Additionally, this strategy needs an even larger portfolio in order to absorb the additional transactions and allow the holdings to be large enough to properly hedge positions. It also takes a lot of additional research to make sure you are getting the best companies for additional potential returns.
For the regular readers of my columns, you know that I am not a big fan of mutual funds and this is one of the reasons. The above strategies are very difficult using mutual funds and/or annuities. The critical aspect of having the above strategy work for you is being able to hedge the holdings, thereby being able to get out of a position quickly throughout the day. Mutual funds are designed more for a longer term hold and don’t really work well for active trading.
As with any strategy you look at, be sure to work with an experienced adviser you trust to work with you on the details of investing your portfolio. This type of strategy is not for everyone and you do need to have a considerable portfolio for this to be effective and work properly.
Gary L. Rathbun is the president and CEO of Private Wealth Consultants, LTD. He can be heard on 1370 WSPD at 4:06 on After the Bell, everyday on the Afternoon Drive, and every Tuesday, Wednesday and Thursday evening at 6 p.m. and Monday through Friday at 10 p.m. throughout Northern Ohio on Eye on Your Money. He can be reached at (419) 842-0334 or email him at firstname.lastname@example.org