Despite its recent declines, Apple stock is still up 543 percent since the market low of March 9, 2009. Even if you bought Apple last year, you still made a hefty 40 percent return. There is no denying that Apple has been a fantastic investment. Maybe you didn’t purchase any Apple stock, so you think you missed out on a great opportunity. But whether you bought the stock or not, unbeknownst to you, you may actually own much more of that famous fruit than you think. Be careful, too many bites of Apple could make your financial stomach (portfolio) hurt if the stock continues to slide.
Watch Your Weight
Most investors use mutual funds to diversify and gain exposure to well known indexes such as the S&P 500 or NASDAQ. Nearly all large cap funds boast having Apple as one of their top 10 holdings. It is true that these indexes offer the opportunity for diversification because of their broad based holdings, but because these indexes are market-cap weighted, their exposure (and your risk) to Apple grows every time Apple stock rises. Indexes are created in one of three ways: price weighted, market-cap weighted, or equal weighted. A price weighted index (i.e. Dow Jones Industrial Average) is heavily influenced by the highest priced stock in the index; a market-cap weighted index is heavily influenced by the largest company in that index; and an equal weighted index is adjusted periodically so that each component has an equal weight.
Many mutual funds and Exchange Traded Funds (ETF) that track the S&P 500 or NASDAQ have seen their exposure to Apple grow over time because most are market-cap weighted. For example, the Fidelity Contrafund (FCNTX) has seen its exposure to Apple grow from 6.9 percent in 2011 to 9.4 percent in 2012; the SPDR S&P 500 (SPY) went from having 2.7 percent of its assets in Apple to 4.4 percent in 2012; and PowerShares NASDAQ (QQQ) has nearly 18 percent of its assets in Apple, up from 15 percent in 2011. If you think you have sufficiently diversified by owning these large cap funds and have a few shares of Apple on the side, you may have too many Apples in your proverbial basket.
Don’t Follow the Herd
Investors and actively managed mutual fund managers alike are known to follow the herd. Fund managers that do not have Apple stock in their top 10 holdings saw their judgment questioned by the fund’s shareholders, similar to when Warren Buffett was questioned by shareholders as to why he would not buy dot.com stocks in the 1990s; Buffett was later vindicated for having avoided the dot.com bubble. During the dot-com era, it seemed everyone was investing in internet stocks. It wasn’t uncommon to hear everyday investors at cocktail parties brag about their investments in Cisco, Lucent, AOL, and other venerable companies that subsequently lost tremendous value when the market collapsed. The people who lost the most in their retirement and investment accounts were those who became overly concentrated in a single sector or stock and failed to diversify out of those positions. They only realized after the fact that they were overexposed to technology stocks. Fast forward a few years, and these same individuals migrated to the next hottest investment – real estate. Many wrongly assumed that real estate would never lose value. After that came the gold craze, and most recently the Apple sensation. What’s next? Facebook?
Use the 5% Rule
While it’s a great feeling to see one of your stock picks skyrocket like Apple has, the reality is that not all of your stocks will be future winners. I always recommend that clients keep no more than 5 percent of their total portfolio in individual stocks because, while individual stocks can have tremendous growth potential, one bad stock can ruin your entire portfolio, especially if that one stock is a large part of your portfolio. No one expected such giant companies like Enron, Fannie Mae, General Motors, Lehman Brothers, AIG, Circuit City, Global Crossing, WorldCom, UAL Corp (parent of United Airlines), AOL, Lucent, etc. to either go bankrupt or completely wipe out their shareholders, but they did, and many people lost their entire life savings. Do not let yourself become overly exposed to one stock or sector of the market.
I am not attempting to predict the future price of Apple or advising against owning individual stocks altogether. I am simply reminding investors of the clear, but sometimes not-so-easy decision to review your portfolio periodically. Make sure you are not overly exposed to any segment of the market, and that you’re not taking on more risk than you can handle.
Ara Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA