You need a long, sturdy ladder if you want to clean the gutters at your house…
Standing on top of a six-foot ladder won’t get the job done. And it’s risky.
You need a jack if you want to change a flat tire on the side of the road…
Trying to pull the deflated tire off the car won’t get the job done. And again, it’s risky.
Think about it…
In life, you need the right tools to get things done. And in most cases, you avoid taking on unneeded risk by using them.
The same thing is true in investing…
As I’ll explain today, a lot of investors unknowingly use the wrong tool for the job. And as a result, they’re taking on far too much unneeded risk.
But fortunately, it’s easy to start using the right tool…
The Federal Reserve is starting to use the word “disinflation.” And we’re closer to the end of the current cycle of rising interest rates than the beginning.
Plus, as my colleague Marc Chaikin said recently, the market is flashing “bullish” signs.
As a result, investors are again turning to cyclical sectors like consumer discretionary.
But if you’re thinking about investing in this space… you need the right tool.
Regular readers know “market-cap weighting” is one of the most popular portfolio-allocation methods. That’s how the Consumer Discretionary Select Sector SPDR Fund (XLY) is set up.
However, it’s the wrong tool to use…
For example, look at Ford Motor (F), Royal Caribbean (RCL), and Darden Restaurants (DRI).
Carmakers, cruise operators, and restaurants all benefit when people spend their extra cash. And they all struggle when people face hard times.
So these three companies give us an all-encompassing look at the consumer-discretionary sector. And yet, they only make up a combined 2.4% of XLY’s portfolio today.
Now, that might be OK if XLY invested in hundreds of other companies that best represent the consumer-discretionary sector. After all, properly diversifying can help reduce risk.
But that’s not the case…
Two stocks make up roughly 38% of XLY’s portfolio. Online-retail giant Amazon (AMZN) accounts for around 23%. And electric-car maker Tesla (TSLA) is about 15%.
Sure, Amazon is a world-class retailer. But is it really 10 times more representative of the retail space than Target (TGT)? The big-box chain’s weight in XLY is only 2.2%.
With such large allocations to two stocks, investors are actually taking on more risk.
Instead, they should turn to the Invesco S&P 500 Equal Weight Consumer Discretionary Fund (RCD). This exchange-traded fund takes an “equal weight” approach to this space.
RCD and XLY own shares of the same 56 stocks in the consumer-discretionary sector. But RCD balances its allocations equally among all the stocks.
That’s important…
An equal-weight approach like RCD spreads out risk for investors. So if the stocks of Tesla or Amazon fall off a cliff, folks won’t get hurt as much as if they put their money in XLY.
RCD allows you to profit from more consumer-discretionary spending. And at the same time, it helps you manage your risk.
It’s a much better tool for investors than XLY – its market-cap-weighted cousin.
And as the markets recover from a rocky year, it’s the right tool to get the job done.
Good investing,
Marc Gerstein
