Having a large portion of your investment portfolio tied up in a single stock can feel like a blessing and a curse. On one hand, if the company performs well, you could multiply your net worth and fast-track your way to financial freedom.
But those big returns to the upside can very easily swing in the other direction, rapidly depleting your portfolio and putting you in a psychological bind as you try to determine whether to sell to prevent further losses or hold out for a potential recovery.
The problem with waiting for a recovery is that it may never come.
According to Aperio’s 2022 paper “Boom or Bust: The Surprising Danger of Concentrated Stock,” over the past 35 years, nearly 40% of stocks in the US market lost more than 50% of their value and never recovered. With over 11,500 stocks in the dataset, that’s over 4,400 stocks that crashed and never bounced back.
Even if you were lucky enough to own one of the companies that didn’t suffer that catastrophic fate, you may have been better off just owning the entire market (aka indexing). Over the same time period, 65% of stocks in the dataset underperformed the overall US market.
So, if you find yourself in a situation where a significant portion of your wealth is tied up in a single stock, what’s your best course of action?
As always, start with your financial goals.
If you are decades away from ever needing the money, have other sources of income, or a sizable portfolio of more diversified assets, you may be able to gradually reduce your risk without trimming your position. If you are able to increase your savings and invest them in a more diversified manner, you can naturally create a less risky portfolio.
But even if you're fortunate enough to be in this position, you should consider the emotional and mental toll you’re willing to endure while riding the inevitable ups and downs along the way. Ask yourself if it’s really worth it. Remember, most people overestimate their risk tolerance when things are going well. Revisit this question when the stock is down 50% and see how you feel.
If you are close to retirement and need to replace your wages with income from your portfolio, a major swing in value could derail your financial plan. While equities can experience steep drawdowns that last for years, a well-diversified portfolio of global stocks will eventually recover, whereas an individual position may never bounce back.
Even if you want to sell a concentrated position, you may be unable to sell if it is stock in a company you work for and are held to minimum holding requirements or restricted trading periods. Or, you may be concerned about the tax implications of large capital gains and want to wait to sell until a later year.
In those situations, there may be ways to reduce your risk while you wait to sell by using options, contracts, derivative strategies, or donating/gifting stock (subject to company policy). But be aware that anything you do to synthetically reduce your exposure will come with added costs, more complexity, or less liquidity. And eventually, you’d likely end up needing to pay the tax anyway.
If you aren’t restricted from trading, the best course of action may be to just sell shares (immediately or over time), pay the tax, and reinvest the proceeds in a diversified manner that helps you sleep at night.
Sometimes, the optimal solution is simple, easy to understand, and provides peace of mind. If you are concerned about the tax hit, a detailed tax projection can help you quantify your options and make an informed decision. If you’re struggling to decide what to do with a concentrated position, feel free to reach out for a professional opinion.
Source: Boom or Bust? Managing Expectations for Concentrated Positions and Risk