Investors need to rebalance periodically, and this is especially true following periods with high volatility. In 2020, the S&P 500 climbed more than 18%, but some subsectors did a lot better than others. Technology stocks and some cyclical industries pulled the S&P upwards, while distressed sectors such as energy, real estate, and financials all finished the year at a loss. As a result, many people are at risk of having too much of their stock portfolio invested in certain sectors, and it's important to take action to manage this.
It's not a great idea for investors to try to time markets by selling completely out of some industries and loading up on others. Remember, timing the market requires both an entry and exit point, so it actually means you would have to nail that timing twice for one investment to pay off. That's nearly impossible to do successfully over and over again, even for the best professionals.
That said, it's sensible to lock in some gains from your best-performing stocks by selling a portion of the holdings and reinvesting those gains elsewhere for balanced growth in the future. This is called rebalancing, and it's an important aspect of portfolio management. After last year, investors who aren't using index funds that rebalance automatically should consider adjusting their exposure to the two fastest-growing subsectors from 2020.
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Information technology
The information technology sector of the S&P 500 consists of internet companies, software providers, data analytics services, hardware, electronics, and semiconductors. This includes tech giants such as Apple (AAPL 0.20%), Microsoft (MSFT 1.57%), Alphabet (GOOG 1.34%), and Facebook (META 2.62%). The sector charged 43.9% higher in 2020 as investors flooded into high-growth tech stocks that were less affected by (or in some cases, actually benefited from) the disruptions associated with the coronavirus. This sent tech valuations soaring, but these companies are enjoying impressive growth to keep investors bullish.
Supposing that someone maintained a portfolio that was equally distributed across each of the 11 sectors of the S&P, information technology would have grown from 9.09% to 11.8% of the total allocation. This might seem like a relatively minor change, but it's actually a pretty large swing. It's especially meaningful when we consider that nearly 34% of the S&P 500 is comprised of tech companies. It's a great time to sell a small portion of your information technology holdings and invest elsewhere.
Consumer discretionary
The consumer discretionary sector is comprised of companies that provide goods and services that aren't necessities. These include luxury items, cars, sporting goods, dining, home improvement, retailers, and e-commerce sites. Amazon (AMZN 0.79%), Tesla (TSLA 2.56%), and Home Depot (HD 0.80%) are the largest companies in the sector, and they were responsible for much of the growth last year.
This is traditionally a cyclical sector that experiences strong performance during strong economic times. The stocks tend to deliver the best returns early in economic cycles, then lag in the later stages. The disproportionate influence of Amazon and Tesla might be changing the sector's dynamics, because these are growth companies completely disrupting their target industries. Despite the onset of a recession in 2020, consumer discretionary uncharacteristically delivered great results.
The consumer discretionary sector rose 33.3% in 2020. In the above example of a portfolio distributed evenly across each sector, this would have resulted in consumer discretionary climbing from 9.09% to 10.9% of the allocation. As is the case with information technology stocks, it would be wise to realize some of 2020's gains in the consumer discretionary sector by selling a portion of them and reallocating to industries with less risk of falling. The sector now exhibits relatively high valuation ratios, which increases the risk of precipitous price declines if there's a market-wide connection amid the current economic crisis.
Investors shouldn't abandon their winners from 2020, but it's smart to recognize the upside potential in beaten-down sectors such as energy and financials relative to the risk in high-flying momentum stocks. Investors who weren't rebalancing in the years leading up to the dot-com bubble and the financial crisis causing the Great Recession would have been over-exposed to those sectors in the resulting market corrections. At some point, other industries are going to come around for their day. Make sure you don't replicate these mistakes and keep yourself appropriately allocated.
