What Is Portfolio Weighting?
A term that is often used in investing is the portfolio weight of a position. This term is used by research firms when they recommend a stock as “underweight”, “equal weight”, or “overweight” for potential investment.
This was confusing to me when I first started investing, but it’s actually pretty simple in theory. What this means is a recommendation that a person hold less, an equal amount, or more of this stock than others held in their portfolio.
A simple comparison is someone who has ten pounds worth of weights. If he has five weights that are two pounds each, they are all equal weight. If he has four that weigh a pound each and then a fifth that weighs six pounds, the heavy one is overweight.
In the same way, you can look at stocks in your portfolio in comparison to each other. A larger than average position is considered overweight, while a smaller than average position is underweight.
How To Calculate A Stock’s Weighting
The first step is to calculate what the average position size is for your portfolio.
In the simple example below, you have five stocks that have a total value of $500, making the average position size $100.
| Value | Weight | Description | |
| Stock A | $125 | 1.25X | overweight |
| Stock B | $200 | 2X | overweight |
| Stock C | $50 | 0.5X | underweight |
| Stock D | $100 | 1X | equal weight |
| Stock E | $25 | 0.25X | underweight |
| Total: | $500 | ||
| Average: | $100 |
Stock A is worth $125, which is 1.25X more than the $100 average, and Stock B is worth $200, which is 2X more than the average, making them both overweight positions.
Stock D is worth $100, which is equal to the $100 average, making it an equal weight position
Stocks C and E are both worth less than the $100 average, making them underweight positions.
An example of this in action is with the DGI For The DIY portfolio, where I have columns for both weighting by value and weighting by income. This can be found about three-fourths of the way down the page, where you can find the embedded Google Docs spreadsheet that I use to maintain my portfolio.
On the far right two columns, you can see how much weighting each stock in the portfolio has for each category.
There are currently 51 stocks in the portfolio, so an equal weighting percentage would just under 2%. Digital Realty is currently the heaviest weighting at ~5%, while Walgreens Boots Alliance is the smallest at 0.7%.
On the income side, Omega Health is the heaviest weighting at 5.7% of dividend income, while Mastercard is the smallest at 0.3%.
I like having this information because I can quickly see how much of an impact each stock has on the portfolio, which can be helpful when deciding whether to trim or add to a stock.
Portfolio Sector Weighting
Another consideration when building a portfolio is what kind of weighting you want to put on each of the different sectors in the market.
Different sectors can have different risk profiles, so I think it’s important to know where most of your investments are located.
Morningstar has an excellent condensed document that discusses stock sector structure, and their sensitivity to the economy.
It breaks it down to three “Super Sector” categories: Cyclical, Defensive, and Sensitive
- Cyclical Sectors
- Basic Materials
- Consumer Cyclical (Discretionary)
- Financial Services
- Real Estate (REIT)
- Defensive Sectors
- Consumer Defensive (Staples)
- Healthcare
- Utilities
- Sensitive
- Communication Services
- Energy
- Industrials
- Technology
It’s important that when building a portfolio, an investor doesn’t get too concentrated in the more cyclical or sensitive categories. This is apparent during the current recession, when healthcare and consumer staples companies have not fallen in price nearly as much as energy, real estate, industrials, and consumer discretionary (restaurants and retail).
For more info on stocks from the different sectors, check out my Sector Watch Lists.
In my DGI For The DIY portfolio updates, I always include an update on the portfolio weighting by sector, showing both weighting by value and by dividend income.
Here are the charts from my most recent update:
As you can see, I try to keep a good balance across sectors, making sure I keep a solid core of defensive companies, while also having some higher growth names from sensitive and cyclical sectors for capital gains.
Personally, I’m of the opinion that you start with a solid base of the more stable sectors like Consumer Staples, Utilities, and Telecoms before branching out into the more speculative and economically sensitive Consumer Discretionary, Industrial, Financial and the like.
Just like when building a house, you want a good foundation for your portfolio!
Chowder is one who’s recommended that approach, especially for older investors who should be “circling the wagons” as they get closer to retirement. If you’d like to read more of his thoughts on portfolio construction, check out the Chowder’s Lost Works found in the Dividend Growth Resources section of the site.
Articles On Portfolio Weighting
Portfolio sector weighting and stock position size weighting are both important consideration with your portfolio.
It’s a factor that I didn’t consider much when first building my portfolio, but have taken more seriously as I’ve evolved as an investor.
Here are a couple articles I’ve written about my own public portfolio discussing its sector weighting and changes I contemplated making to improve it.
Shuffling My Dividend Growth Deck
Dividend Growth Diversification: A Deeper Look At My DGI Portfolio
Dividend Growth Diversification: Upping My Health Care Sector Exposure