Warren Buffet’s “Circle of Competence” theory — which he explains in detail in his 1996 letter to investors — states that to invest successfully, you have to stick to buying companies whose industries and business models you know well. That’s the main reason why he avoided tech stocks during the late-90s tech bubble — in retrospect a smart move, even though it meant giving up some big gains for a while.
But, Buffett wrote in that same letter, buying individual stocks isn’t the best way to invest:
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.”
Knowingly or not, many investors seem to follow Buffett’s advice. When it comes to individual stocks, they buy companies they know. When it comes to funds, many turn to low-cost ETFs and index funds. That, at least, is what our recent analysis of the most popular holdings in SigFig users’ portfolios shows.
We started out with a simple premise: let’s find out if people invest differently based on their age. To do that, we split SigFig users into seven 10-year age groups and looked at the top five holdings – ranked by number of users who own those holdings in their portfolios – for each group.
Among our findings:
Everybody Loves Apple
The most popular holdings in younger investors’ portfolios seem to be the stocks of companies whose products they use every day, like Google (GOOG), Facebook (FB) and Apple (AAPL). Older investors seem to feel comfortable owning well-established, stable companies like AT&T (T), Johnson & Johnson (JNJ)… and Apple. In fact, investors in all age groups own Apple stock.
Even if you’re buying what you know, you should still properly diversify your portfolio. Yet, our analysis shows that investors under 40 are putting an average of nearly 15% of their portfolios in Facebook stock. That’s a big risk to take on a single company.
We can speculate that some of these highly concentrated investors might be Facebook employees who are getting stock as part of their compensation. But that might be an even bigger risk. If you both work for a company and own stock in it, you’re doubly exposed if something happens to the firm. The value of your stock would fall — and your salary would be at risk, too. Some financial planners believe you should keep no more than 10% of your portfolio in your employer’s stock. Others say no more than 5%.
In fact, some mutual fund companies will tell you that to be properly diversified you probably shouldn’t have more than 5% of your portfolio in any single company stock.
Mutual funds and ETFs are an easy way to spread your risk among a basket of stocks or bonds, across multiple companies or even industries. And just to be clear, across all age groups, investors own a wide variety of funds and ETFs as well.
In fact, investors in their 20s, 30s and even 40s seem to favor low-cost ETFs, some of which you can see ranked among the top 5 holdings per age group (again, calculated as number of investors who own the security, rather than assets invested). One reason why we don’t see more funds or ETFs in our ranking could be a matter of choice: investors who want to own a total stock market fund have plenty of ETFs and index funds to choose from; investors who want to own Apple… well, they go and buy AAPL.
Look at Your Overall Portfolio
If you’re set on playing with individual stocks in your portfolios, keep in mind: the index funds you already own may hold the same big-name stocks you are buying.
Take, for example, Millennials’ love affair with Apple. In our analysis, two of the most popular holdings for the under-30 age group’s are Apple and the Vanguard Total Stock Market ETF (VTI). The top holding in the VTI? Apple, at 2.57% (as of market close on August 19, 2014).
When you’re deciding whether to buy an individual stock, it’s worth doing the math to figure out how much exposure to it you already have.
A couple of notes about this research:
- SigFig only tracks data for its users, which may not be representative of all investors.
- As previously stated, we ranked the top five securities in each age bracket by number of investors who own this security – not by assets invested or average percentage of users’ portfolios.
We all have biases. And it’s all too easy to think to yourself, “Everyone I know uses this company’s products, therefore it can’t fail.” But trying to outsmart the market tends to be a losing bet for most investors, most of the time.