This is a guest post by Hank Coleman. Opinions belong solely to the guest post writer and do not reflect Jemstep.
Like most investors, you probably think that your investments are diversified. But are they really? When was the last time that you checked which individual stocks your mutual funds owned?
A lot of investors do not realize that many of the mutual funds they own invest in many of the same stocks from the most popular companies on the market. According to a recent report in USA Today, more than 700 stock mutual funds own shares of Apple stock. In fact, more than 400 mutual funds have Apple as its largest position.
The Stock Market Darlings Ruin Us
Despite Apple?s recent slump ? its stock is down more than 20% from its highs ? most of us own shares of Apple whether we realize it or not. It?s found in popular mutual funds like Fidelity Contrafund, T. Rowe Price Growth Stock, and American Funds Growth Fund of America. It?s in our pension plans, in exchange traded funds, index funds, and the individual shares we gobble up as investors.
If you own shares of an S&P 500 Index and the Nasdaq 100 Index, then you own a lot of shares of Apple. Last year, Apple comprised over 17% of the Nasdaq 100 index, dwarfing the other stocks in the index. Shares of Apple now also account for almost 20% of the S&P 500?s tech sector.
Apple is not the only stock in which many people are overweighted. The same can be said for General Electric, Coca-Cola, McDonald?s and many others. There is a significant danger of holding too much of a certain stock without realizing it.
Fund Overlap Is A Big Problem
With so many mutual funds owning shares of the same companies, it is too easy to become overweighted in a single stock ? without even realizing it.
There?s a danger when a company?s stock becomes so popular that everyone wants to own it. You might think you?re diversifying by owning many mutual funds, but those funds? holdings overlap with each other. Investors compound the problem when we purchase individual shares of these popular stocks in our own trading accounts. We?re sometimes shocked to discover that we?re not as diversified as we should be.
The Danger Of Not Being Diversified With Your Investments
Most investors understand the importance of diversifying their stock, bond, and mutual fund holdings. Diversifying keeps investors from suffering a more devastating loss if one stock suffers a setback.
Classic finance theory tells us that a company?s stock price is the present value of its future earnings. Yet the stock is still susceptible to market risk, headline risk, political risk, credit risk, and other unsystematic specific risks that will affect one company and not the market as a whole.
You cannot avoid systematic or market risk, but you can minimize other risks by diversifying your holdings. Without diversification, you increase the likelihood that one stock?s poor performance could bring down your total investment portfolio. Diversification is a way to protect your returns from being skewed by one outlier.
Look At Your Investments As A Whole
Examine how each of your mutual fund holdings and individual stock positions overlaps with one another. Consider any pensions or 401(k) retirement plans and their holdings as well. What do they invest in? Are you already investing in those stocks or shares in other holdings? Are your individual stocks over-represented in your portfolio because they are in a popular stock index? These are all things that you have to consider when finding out if you are truly diversified.
Scan Your Mutual Funds For Overlap
Scan your mutual fund holdings online to ensure that you?re not suffering from too much mutual fund overlap. Jemstep has an excellent tool that can help you screen your mutual funds and their holdings.
Do you think that your investments are diversified? Do you know what your mutual funds are holding? Your hard work could be negated if that large position takes a nosedive. A portfolio making a decent rate of return could struggle to keep up with inflation if your largest holding suffers a set back.
Hank Coleman a financial planner and personal finance writer with a Masters degree in finance and a graduate certificate in personal financial planning. He spends his time answering questions about investing, retirement, insurance, and other money topics on his site, Money Q&A.
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