Acknowledging the Risks of Concentrated Stock Positions

It is not unusual for affluent investors to have concentrated stock positions.

An inheritance, equity compensation structure, sale of a business, IPO, or a fortunate stock investment can result in an outsized holding in a single security. During periods of low volatility and rising prices, a concentrated position may not seem like a problem.

But we all know that markets don’t move in one direction for long. Volatility happens, corrections occur, and a concentrated position can quickly become a vulnerability.

Even when you are looking at relatively small dips and recoveries in a portfolio, history has shown that volatility can put what’s known as “drag” on compounded growth.

Although all equity investors face market risk, those with concentrated positions also face risk that is unique to that single stock. Historically, volatility, as measured by standard deviation, is greater for single stocks than for a diversified portfolio. While past performance is no guarantee of future results, this can mean that over time your concentrated position may reduce your overall returns, in contrast with a diversified portfolio.

In addition to long-term risk, you may also run the risk of abrupt loss. Equities are unpredictable, and companies may have problems that are not readily apparent. Even large, established, well-managed companies can experience sudden challenges that drop their stock price, or worse, force them to go into bankruptcy.

Why Investors Balk at Letting Go of Concentrated Positions

Despite the risk potential, investors with concentrated positions often tend to hold onto them. They may:

• Believe the stock will outperform
• Wish to defer capital gains taxes, especially if the cost basis is low
• Have an emotional tie to the security, often for personal or family reasons

There may also be issues with selling a concentrated position if it consists of restricted, unregistered, or controlled securities.

Concentrated Stock Strategies that Help Reduce Risk

There is no one-size-fits-all solution for managing concentrated holdings. Factors such as individual risk tolerance, investment horizon, desired returns, and asset allocation within a portfolio should be considered carefully.

Some possible courses of action include:

• Staged selling: Gradually winding down a concentrated position in order to spread out capital-gains over time.
• Charitable giving: Investors, especially those with an emotional tie to their concentrated position, may prefer to make charitable gifts during their lifetime. Several charitable giving strategies may be available to help minimize taxes.
• Outright liquidation: This applies only to unrestricted shares and may not always be the best answer. Proceeds may be redirected into other investing opportunities for diversification.