Having a diversified portfolio is an important thing for investors of all stripes, though it is particularly important for long-term investors.
Diversification helps protect portfolios from adverse events because it limits exposure to sector-related risks. While the micro-chip shortage is hitting hard across all industries, it just hits different in the tech industries where if you don't have chips, you don't a product.
To shield yourself from the dangers of a poorly diversified portfolio, you should trim positions as they grow. This means partially divesting from positions that have grown a lot, while reallocating the funds into non-correlated positions that have grown at a slower pace. This re-weights your portfolio and limits the damage that any one position can do to your portfolio.
And while that is simple enough and is essentially a beginner’s trick, diversification doesn’t always mean that the companies are from different sectors, or even industries. This rings true in the technology sector especially, as the sector has become something of a catchall phrase.
In the Technology sector, you have you semiconductors and hardware companies, where there is certainly a lot of overlap. But then you also have software infrastructure and applications that use already built technology to offer a good or service. Furthermore, you also have information technology, which includes technical support, consulting, and supply chain management companies. All very different.
And while, sure, all of these companies rely heavily on technology and a semiconductor shortage does hits some of these industries hard, that doesn’t guarantee that they are all highly correlated. Increases in oil prices can have a big influence on share prices in shipping companies, but that doesn’t mean that FedEx (FDX) and United Parcel Service (UPS) should be trading in the Energy sector.
Furthermore, companies can start off in the Technology sector and later be moved elsewhere as its market grows and technology ceases to be the best description. While the technology sector didn't exist when trains were invented, it seems like anything with a steam engine would have been lumped into the same sector, putting factory equipment and locomotives in the same sector, in fact, this is likely why railroads and many transportation-related stocks are still in the Industrials sector.
So while Solar companies trade in the Technology sector for now, at what point will they be transitioned over to Energy?
Furthermore, there are a plethora of companies that trade in the Technology sector that create technology for certain kinds of businesses, including Biotechnology. So even though they are mostly just creating technology, they are often pretty specialized, which makes the prices of those stocks not overly correlated with other Technology stocks.
As your portfolio grows and you prepare to trim winners, be aware that a reallocation simply across sector and industry lines does not always mean that those dollars invested are “diversified” per say.
Furthermore, don’t feel like because you hold Apple, that you can’t also hold NVIDIA and/or Shopify. If you find a stock and are not sure if it can fit in your portfolio, check its beta against stocks that you do hold to see how it moves with the market. If it moves in-line with the market, and all of your holdings are already doing that, then it may one to pass on. However, if it doesn’t move the same as your holdings, it may just be a victim of the catchall nature of sectors and industries and could still be worth a buy.
