What if you could improve your portfolio performance just by paying attention?
When a marriage is on the rocks, the first thing many couples are counseled to do is to pay attention to each other. I know that my marriage goes more smoothly when I pay attention to what my husband says -- rather than being lost in a book all the time. When you aren’t paying attention to your partner, you miss important cues, whether it’s body language or tone of voice.
Missing those important cues can lead to an unfulfilling and difficult marriage. You have to pay attention and make proper adjustments, if you want your relationship to work.
The same principle holds with investing. You need to pay attention to market cues if you want to boost your portfolio performance. If you are willing to do that, it's possible to boost the returns you receive from your ETFs through what is called sector rotation.
What does this mean for you? You can limit losses at certain times, and increase your gains at others.
How Sector Rotation Works
Not everything in the markets moves together. Commodities don't always move with stocks, for example. Even within the stock market, not all equities move in the same direction at the same time.
Those who can spot trends in how various sectors relate to each other have an advantage: They can rotate their ETFs to take advantage of what is most likely to offer returns now. Then, as a sector weakens, it's possible to sell the ETFs and invest the money in sectors that are likely to rise next.
Watch for sectors and market segments likely to do well in coming months. Then, invest in ETFs that track the appropriate indexes or sectors.
ETF Rotation Strategies
Here are two ETF rotation strategies.
Seasonal Cycles
Certain sectors see a boost during certain times of the year. Some good times to invest in retail are just before back-to-school, and just before Christmas when more people shop. As retailers see more profits, retail ETFs rise.
During the spring, many real estate ETFs have the potential to pick up, since more inventory is moving. Also, when the summer travel season ramps up, many companies on the oil supply chain see more profits, and travel and hospitality businesses often experience increased profits.
Once you understand how the seasonal cycle affects different cycles, you can buy just before that season (while the price is low) and sell just before the season ends (taking your profits before the sector drops again).
Economic Cycles
While it's nice to think that the economy might grow indefinitely, economies run in cycles. Economic expansion is followed by recession -- or even depression. Paying attention to the economic cycles can help you figure out what is likely to outperform.
In a down market, when everything is mostly lower, the best you can do is to invest in sectors that are likely to see improvement first. In many cases, consumer products (such as toilet paper, toothpaste, etc.) remain reasonably steady throughout a down cycle, since these are items that people always need. Discount stores also tend to retain some of their pep, since consumers are looking for a deal. Utilities can outperform other sectors as a market weakens, since these are not things people feel they can get rid of.
As the market improves, so too do the technology and basic materials sectors. Understanding how different sectors respond to economic conditions can help you make better decisions. If it looks as though a market is heading lower, it's probably time to sell technology-related ETFs while you can take profits, and invest in a different sector (such as discount chains selling consumer necessities) while its prices are reasonably low. Rotate back into technology after the economy seems to have bottomed out and you can still get some good deals.
The Investing Answer: Of course, there is no way to completely predict the perfect entry and exit points. You are working on past trends, and past performance doesn't predict your future results. However, if you get used to the ebb and flow of seasonal and economic cycles, it's possible to create a plan that allows you to rotate your ETF sectors in a way that lets you take advantage of what's coming next.
