Underweight Overweight

Investment decisions often lead to questions about being underweight or overweight. What does this imply?

Using words with prepositions in them imply that there is a reference point somewhere. This is true of asset allocation when using the words underweight and overweight. There is an implicit assumption that a weight exists (i.e. a percentage of the value of your investments) that is equal to something. I wonder how much we question what that something is? And what should we consider when deciding how much to invest into each asset in our portfolio?


The use of benchmark indices has been widespread in modern investment processes. The good thing is that they provide a kind of consensus of how all investors in the market are doing, because they measure the performance of whole markets. But they have been a two-edged sword, with investment managers so fearful of underperforming the benchmark they’ve been set that they try to only make small deviations from the index weightings. This “benchmark hugging” blurs the lines between active and passive investing, where passive investing in this case means religiously tracking the benchmark. An investment manager can lose a contract or, as an individual, their job if they underperform the benchmark by too much or too consistently.

Thus, if a particularly large constituent of an index, let’s say with a 10% weight, is rated as a poor investment choice, the investment manager might choose to hold 8% instead, rather than zero. A small er constituent, with perhaps 0.1% weighting, can be omitted in its entirety.

But need that concern the private investor? I would say, no. At least, in isolation, no. As a private investor, you have responsibility to nobody but yourself. You are free to set your own investment goals and nobody is going to fire you for missing them. But there are other considerations.


One thing a benchmark typically forces the investor to do is to diversify. Many benchmarks are market capitalisation weighted, meaning that the largest companies have the largest weight and consequently the largest impact on the calculation of returns. There are questions to be asked as to how much diversification they really offer, as some constituents and/or sectors dominate the benchmark index. In the UK, for example, the FTSE 100 and All-Share indices are dominated by the oil, pharma and financial sectors. In the USA, there is a large technology sector, and we are likely to find a typical US investor holding a greater weight in technology stocks than a UK investor. So following index weightings provides some diversification, but if diversification is the aim, there are better ways of achieving that, such as equal weighting or one of the newer indices designed to provide maximum diversification.

Just one warning about diversification, though. While it reduces the volatility of our portfolio by spreading out the risk, it also diversifies your ignorance. And that’s from the world’s best known investor, Warren Buffet.

Investment Goals

There is no getting away from setting your own investment goals. Why are you investing into financial markets in the first place? Is it simply to gamble? Is it to provide growth, perhaps because you are managing your own pension fund? Is it to provide income, because you want to enjoy rising dividends from less risky investments? Is it to hedge against future liabilities, like paying off a mortgage? Whatever the aim, the investment strategy will be different from that of other aims. And probably different from a benchmark, too.

So the correct weightings are….?

The correct weightings are those that achieve your investment goals. If the only concern is that you don’t want to lose money, then put it into a bank, preferably a bank backed by the government (National Savings in the UK). But whatever the investment goal, the chances are that there is no benchmark that suits. If you believe a company that is 10% of an index is going to lose value, then hold no shares in it, that’s the only “underweight” that’s meaningful. Although you might be unsure and want to hold a small amount. If you are investing for income, you probably want a mix of stocks and bonds, depending on your appetite for risk. In the current low interest environment, the yields on bonds is very low, and you are likely to do better by holding a mix of high-yielding equities. There are even high yield ETFs, and dividend growth ETFs that will suit.

The only meaning for underweight and overweight that applies to you is probably as follows

  • Overweight: it’s in your portfolio because you can justify it as part of your investment goals. But you hold rather a large weighting and your diversification suffers.
  • Underweight: it’s not in your portfolio but should be. Such as some gold just in case markets crash.

Money Questioner’s portfolio

My glib one-liner when it comes to investment goals is: buy a farm, an oil well and a care home. That way you have everything you need in your retirement. I mean, what’s the point of holding shares in an advertising agency or a shipbuilder unless you are treating the stock market like a casino? My portfolio is heavy on energy and health. It is also heavy in emerging markets, which I believe offer some protection against developed economies losing out to lower cost manufacturing etc. I am also heavy in mining companies for similar reasons to energy – they represent future expenditure. Away from equity growth, I want my portfolio to have investments that are like cash. I have some risk appetite, so I don’t need any government debt. I have some corporate debt but that is being reduced as it’s done its job. I have some infrastructure funds and some property funds, which have low volatility and again are pseudo-cash. There are some speculative investments in there too, which my broker gave me good reason to buy as a “punt”, but I really don’t think about these very much.

My investment goals are mostly met, and I have no idea how the investment returns compare to a benchmark index. Which might sound odd, given my long career in constructing and calculating indices.

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