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The 2-Stock Strategy That Destroyed the Market

Alex Dumortier
February 19, 2012

There's a two-stock portfolio that handily beat the market over the past decade with virtually the same volatility -- in fact, it experienced fewer 10% monthly losses than the S&P 500 did during that period. In my opinion, there's also a pretty good likelihood that the same portfolio will beat the market over the next decade (but not by the same margin). Thinking through this strategy will help you to see the goal of beating the market in a different light, particularly if you invest in or want to invest in high-growth stocks.

Violating finance theory for fun and profits
Much higher returns with similar volatility? That would appear to violate standard finance theory, according to which higher returns require higher risk. Here's the trick: One of the two stocks is the market: an index ETF such as the State Street SPDR S&P 500 ETF (NYSE: SPY  ) or the Vanguard S&P 500 ETF (NYSE: VOO  ) . The other stock is Apple (Nasdaq: AAPL  ) , the 800-pound gorilla that is the fruit of the union between an electronics whiz and a lifestyle guru. I'm not going to teach you anything by telling you that you would have done very well if you had owned Apple shares over the past 10 years, but what may surprise you is the impact that kind of performance can have on total portfolio returns over time.

I ran the numbers on a portfolio initiated on Jan. 31, 2002, with a 95% weighting in the S&P 500 and a 5% position in Apple. Over that period, a $10,000 investment in the SPDR S&P 500 ETF would have grown to $13,998 for a meager 3.5% annualized return (Vanguard's ETF didn't exist in 2002). This "Apple-juiced" portfolio, on the other hand, weighed in at $31,765 for a highly satisfactory 12.3% average return.

The Apple-juiced portfolio
Adding Apple juice to the portfolio made a huge difference -- nearly $14,000 worth on an initial $10,000 investment, and the volatility of the portfolio wasn't much higher than that of the index portfolio. One immediate objection to this strategy is the discomfort the rapidly ballooning exposure to Apple would cause most investors. In four years, the Apple position went from 5% to one-fifth of the total portfolio value; at the end of the 10-year period, the figure was close to 60%.

There is a compromise strategy that addresses that concern: rebalancing the portfolio to the original weights on an annual basis, such that at the end of every calendar year, Apple once again represents 5% of the portfolio. That strategy, "Apple-light" if you