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One stock is the loneliest number when it comes to investing

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recordThe U.S. markets have had a great run this year. They may be entering a phase of correction as I write.

Some stocks affect markets more than others.

Falling back to Earth

Remember Apple — everybody’s darling? Have a look at a post  from back in April, 2012.

What goes up spectacularly, can come down spectacularly

Over one year, Apple fell nearly 40 per cent from its peak. While Apple may have done very well long-term, if you held Apple over the last year, you’re investment dropped 40 per cent from its high. It acted as a drag on the S&P 500 and the Nasdaq just as it lifted both during its run. That’s 40 per cent of your investment or very nearly the amount the broad markets came down during the financial crisis, an amount that caused many investors to rethink their risk tolerance.

One, is indeed, the loneliest number

You should never hold just one stock, no matter how well it’s done. Sure, you can do very well, but what some forget is that your risk goes into the stratosphere with your investment.

Apple as case history

Apple’s downturn presents a strong argument for diversification.

Steve Job’s heirs were being advised to sell Apple and diversify even before Apple hit an all-time high. But that story didn’t capture much attention.

One is the riskiest number

The reality is, that in investing, one is the riskiest number. There’s a reason most investment professionals own anywhere from 30 to 300 stocks or more in a broadly based portfolio. Broad indices may even go as high as 500 stocks (S&P 500) or 1,000 or more (Russel 1000).

Grow slow**

And this is why diversification is so important. While it’s true everyone’s a winner while they’re winning, it’s also true that spectacular runs in individual stocks can come to an end.

Apple’s future? Unknown. But principles of diversification are well-known, tested over time, and retested. There are aberrations, but even better, investors sleep at night when they know their risk tolerance.

As Apple stalled, the broad market accelerated

We may be overdue for a correction. U.S.-based indices like The Dow Jones Industrial Average (DJIA) hit a record while the broad S&P 500 fell from its nominal high recently. Both indices have performed very well.

Both indices were bargains after ten years of relative underperformance, especially compared to the Canadian market and a soaring Canadian dollar. After the financial crisis, and the ensuing market correction, few wanted U.S. stocks (or any equities). But they were extremely cheap.

Is big better?

As money came out of Apple, the broad markets took off. We’re not just talking big … Apple had reached monolithic proportions. Articles like this are often a warning to investors. A warning that often goes unheard.

Can’t you just see Tim Cook breaststroking through cashmoney? I can.

— The Atlantic

Was Apple absorbing a lot of investment capital? Considering the huge cash position Apple held (over $100 billion U.S.) was that capital being used well or was it being used as a buffer against the inevitable slide in Apple stock?

Investors looked out at investment opportunity, increasing competition for the iPhone and decided to take profits and put their money in more companies in different businesses. After all, while some may argue the opposite, does any country create lasting success through the overwhelming dominance of one company in its markets?

The history of antitrust law would say no. You be the judge.

You’re risk tolerance may be severely tested only once every ten years, but when it is, what you thought you knew about yourself can change as fast as the passage of that ray of light that just went by but left the sun eight minutes ago.

Click here for more about bonds/fixed income investments.

Click below for more about asset allocation and reallocation strategies:

Get the balance right

A simple way to arrive at the right asset allocation for your portfolio

Plan like a pension fund manager when it comes to your investment portfolio

Let’s think about assets

Asset allocation: Diversification is king

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* Based on an average basket of Canadian dividend-payers

** Recent activity in gold adds fuel to a philosophy of owning dividend-payers during tough times, the dangers of volatility for investors who haven’t diversified and the perils of overweighting one speculative sector or stock, no matter how “safe” the crowd thinks it is

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Written by johnrondina

April 8, 2013 at 2:35 pm

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