When looking at asset allocation, there usually are many asset classes to consider.
The first: Stocks, bonds, and other (eg real estate or derivatives)?
The second: Domestic vs international?
The third: Large cap, mid cap, and/or small cap?
And then another consideration, the fourth: Market sector.
After allocating across the above classes via mutual funds, market sector diversification doesn’t usually get much attention.
It tends to be assumed that diversification across market sectors immediately occurs by nature of holding the various asset classes 1-3 above.
And indeed, that can be the case. An argument can be made, and often is, that holding large and small cap of various geographies can add diversification.
Just by the nature of how the indexes for a certain large or small cap composition are comprised, different weights occur for different market sectors.
They each are stock funds. They each are international (developed and emerging) markets. One is small cap. One is primarily large cap.
So that’s pretty good diversification, but we benefit as well from market sector diversification just by the different market sectors the companies on each index are in (rounded to nearest %).
FTSE All – World ex US Index FTSE Global Small Cap ex US Index
Basic Materials 7% 7%
Consumer Goods 17% 11%
Consumer Services 8% 13%
Financials 27% 22%
Health Care 9% 6%
Industrials 13% 24%
Oil and Gas 6% 4%
Technology 5% 8%
Telecommunications 5% 1%
Utilities 4% 2%
This is an added benefit that may lead to lower correlation within a portfolio’s asset allocation.
Diversification within and amongst the asset classes within your asset allocation are the means to achieving an optimal rate of return, helping you reach your financial goals over time.