Your portfolio may not be as diverse as you think. Diversification is an important tool for reducing the effects of long-term volatility while maintaining long-term goals, but your portfolio can be inadvertently concentrated.
One of the main ways this happens is when you own an individual stock that is also a large component of a mutual or exchange-traded fund. Apple, for example, has been a major driver of the S&P 500’s performance for several years. Today it accounts for about 7% of the S&P’s weighting. Microsoft isn’t far behind at around 6%, followed by the combined share classes of Alphabet (aka Google) and Amazon, both in the 4% range.
Just by owning these four companies you could own a fifth of the S&P. So if you own an index fund that tracks the S&P or another fund with these stocks, you’ll own more of these stocks than you might think.
Mutual funds are another common source of duplication. Controlling common properties here is more difficult, because by the time you see the composition of a fund, several months have already passed. Fund managers may have increased or decreased their position in the stock since then. In any case, your fund advisor or brokerage may have a tool that helps you check for duplication in your funds; if not, you can at least check the top properties on most financial news sites.
Remember to check all your portfolios, including your spouse’s holdings. If you participate in an employer-sponsored retirement plan and have an IRA along with a taxable investment account, you’ll want to look at combined holdings.
Discuss with your financial advisor an appropriate level of exposure to an individual stock. Opinions vary, but limiting the weight of each individual holding in your overall portfolio to 5% or 10% can be a good goal.
Finally, don’t just look at individual properties. For example, if you own two large-cap funds, does owning both provide additional diversification? For stocks, aim for a range of holdings in terms of company size (either by revenue or market capitalization) and industries. Bond investments should also be diversified by credit quality and types of issuers (government and corporate).
If you have unintentional overlap or are overly concentrated in one holding, you can downsize or sell the holding and invest in an area where you don’t have as much exposure. Make sure you understand the tax consequences of the sale and whether it makes more sense to make changes to a tax-deferred account than a taxable account.
Also, sometimes a holding becomes overweight in a portfolio because it has been particularly successful. A rapid increase in the share price, for example, can quickly move its weighting in the portfolio from 10% to 20%. There is often no need to reduce your position in this investment immediately in order to meet diversification objectives.
In these cases, consider allowing ownership to remain outside of your target percentage while reducing ownership. Sometimes it’s best to let your winners keep running.
Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a member of the 2018 Forbes Next Generation Advisors list and a financial professional at Avantax Investment ServicesSM. Evan leads a team of retirement transition strategists for clients who consider themselves The Millionaire Next Door. He can be reached at 941-500-5122 or [email protected] Read more of his insights at heraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC. Investment advisory services provided through Avantax Advisory ServicesSM, insurance services provided through an insurance agency affiliated with Avantax. 8225 Natures Way, Suite 119, Lakewood Ranch, FL 34202.