What Is Underweight in Investing?

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DEFINITION
The term “underweight" refers to a fund or portfolio with less of a percentage of a certain stock or sector than the benchmark it’s measured against.

The term “underweight" refers to a fund or portfolio with less of a percentage of a certain stock or sector than the benchmark it’s measured against. Brokers and fund managers use the term “underweight” to refer to their outlook for a particular stock or market, often when it’s a good idea to reduce that investment.

Understand what underweight in investing signals to investors, why it matters, and how to use this weighting to balance your investment portfolio.

Definition and Example of Underweight in Investing

An underweight investment is a type of investing recommendation that implies it’s best to reduce investment in a certain asset class or security. The recommendation is made according to how the investment is measured against a particular benchmark. Underweight investments have less of a percentage of a certain stock or sector than the benchmark they're being measured against.

The investment may be viewed as underweight if U.S. equities make up 40% of the benchmark portfolio and there is concern that U.S. equities will underperform. One potential solution would be for the investor to reduce their exposure to U.S. equities, and invest more in an overweight stock or fund instead.

Low-cost index investing generally focuses on market capitalization-weighted indices. It requires an index investing approach that prioritizes the largest companies within an asset class.

For example, if the top 10 companies listed in the S&P 500 Index make up more than 25% of the entire index when the price of a security increases its weighting, the portfolio will increase as well. The most overvalued companies can become overweight when this increase happens. The most undervalued companies (or companies with a price that has appreciated or depreciated) will become underweight.

How Does Underweight Work in Investing?

Weightings hold a lot of significance. An investment can be considered underweight or overweight. Brokers and fund managers generally use terms such as “underweight” and “overweight” to signify their outlook for a certain investment in relation to how it’s performing against a select benchmark.

A broker buys and sells securities on behalf of their customers. Fund managers are responsible for overseeing the allocation of the pool of money invested in a particular mutual fund.

An investment advisor may say something is underweight when they expect that stock to underperform the market. On the flipside, an advisor, broker, or fund manager may say a stock is overweight, and they may recommend you increase your investment in it by buying more shares.

What Underweight Means for Investors

The term “underweight" is important to understand if you invest, regardless of whether you have a broker or fund manager helping you manage your investments. You can use this weighting system to determine how to best balance your portfolio. Having a balanced portfolio means you invest in a mix of bonds and stocks to reduce your exposure to potential volatility. If your portfolio is underweight in one area and overweight in another, it may be reflective of your risk tolerance, or it may be time to rebalance your portfolio.

It can be helpful to rebalance your portfolio at least once a year, or even more regularly if big moves in the market occur.

Ideally, your investment portfolio will always line up with your risk level. You can revisit your allocations and rebalance your portfolio by selling overweight positions and buying underweight ones if you find that recent market volatility has made you nervous, and you're reconsidering your investments.

Rebalancing regularly serves an important purpose. You can return your portfolio to its original target allocation when you regularly sell overweight positions (in relation to the rest of your portfolio) and replace them with ones that are underweight.

Key Takeaways

  • The term “underweight" refers to a fund or portfolio with less of a percentage of a certain stock or sector than the benchmark it's being measured against.
  • A stock that's labeled as “underweight” is expected to underperform the market.
  • If a stock is labeled “overweight,” that's often a recommendation to increase your investment and buy more shares.
  • You can rebalance your portfolio by selling overweight positions and buying underweight ones.

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