Despite the mountain of articles available that discuss the benefits and methods of diversification when investing, there are still many situations where an investor may find (intentional or not) where they have a concentration in one or more common stock holdings in their portfolio. While there are those who espouse steel king Andrew Carnegie’s adage to “put all your eggs in one basket, and watch that basket,” modern investment wisdom and endless studies state otherwise.
What constitutes a “concentrated stock holding”? For many, a holding that makes up more than 10% of your net worth is considered as such. Most wealth managers will say that any holding that exceeds 10% of your portfolio is excessive and invites specific risks, such as: single-company risk, management risk, legal risk, and technology risk. In short, any risk that could affect the underlying company’s operations or profitability could present an appreciable risk to your portfolio and your wealth.
How Does Concentration Occur?
Most investors are acquainted with the notion of diversification, so how does a concentrated stock holding situation occur? For those who are fortunate enough to work for a company where a retirement benefit is the ability to acquire company stock through the company retirement plan, concentration in the employer stock is a common occurrence. If the employee takes enough advantage of the opportunities and the company does well over the years, the holding can easily exceed 10% of the company 401(k) plan.
This often also leads to another situation over time: inheriting a parent’s IRA that is heavily invested either in the deceased parent’s former company’s stock, or even if the parent was fortunate enough to get in early on a successful tech company like Apple, Microsoft, Amazon, or Google, where the stock has appreciated significantly over the years and the parent was reluctant to sell.
Why Do Investors Hold On to a Concentrated Stock Position?
Human behavior biases may lead investors to hold on to these stocks. These include:
- Sentiment: Those who acquired employer stock may feel a strong sense of loyalty to their current or former company—due to, through their work and career, having contributed to the company’s success—and thereby to the growth of the stock over the years. Similarly, heirs of such stock may be reluctant to sell based on loyalty and affection for their deceased parent(s). Holding the stock, regardless of the merits, may trigger memories of their parent or even the experiences of their parent’s career while growing up.
- Anchoring: Investors have a tendency to latch onto a particular holding or, more often, a value of a holding, portfolio, or even real estate value. This “anchor” is an emotional reference point, leading to avoidance behavior by not taking action to actualize a loss/the pain of that loss.
- Overconfidence: If the stock concentration is that of a former employer or was the result of some good stock-picking, the investor may feel overconfident in their knowledge of the company and its prospects for growth or the stock’s potential for gain.
- Regret avoidance: The investor may be reluctant to diversify the holding due to potential regret if the stock should gain further or in hopes that a current loss will turn around at some point (realized loss avoidance).
Reasons to Hold Concentrated Stock
While there are abundant studies and reasons to support the recommendation to diversify away from concentrated stock positions, there may be valid reasons to maintain one’s position:
- The investor has reasonable confidence or knowledge about the particular company and its future prospects. Perhaps the investor is/was part of senior management or an expert in the technology or operations used by the company to achieve its business success.
- The investor may be a major shareholder where retaining voting power is a significant objective.
- Legal or contractual reasons that prohibit divesting the position, even in part.
- While understanding the above-stated risks, the investor has significant unrealized capital gains in the stock and, being in the latter years of their lives, would like to take advantage of the tax laws regarding “step-up” in cost basis, where the heirs of this stock may avoid taxes on the gains when sold later.
- The stock is a conglomerate company whose divisions and operations are diversified across many industries and sectors and is financially strong and managed well enough to withstand normal business and economic cycle fluctuations.
Getting a Second Opinion
Most investors would benefit from a second look at concentrated stock holdings and obtaining recommendations on whether to retain such positions or strategies to effectively and tax-efficiently diversify their portfolio. Experienced wealth managers, such as those at Deerfield Financial Advisors, can be helpful in exploring the how’s and why’s of holding individual stock and discussing strategies that best fit your objectives and future goals. If you have questions about your portfolio or having a large amount of any stock, or if I can help in any way, call (317) 644-7701 or email mroop@deerfieldfa.com.
About Matt
Matt Roop is Wealth Manager and Shareholder at Deerfield Financial Advisors, a fee-only financial services and wealth management firm with offices in Indianapolis and Chicago. In his role, Matt acts as a personal “chief financial officer” for his clients, overseeing every facet of their financial landscapes, orchestrating strategies to grow their wealth, and enhancing their financial clarity. Catering to the distinct needs of lawyers, engineers, and business owners, he empowers them to embrace their passions and lead their optimal lives. Matt conveys a depth of experience and a calm demeanor that clients find reassuring and soothing, and he loves providing peace and confidence around their financial future.
Matt received a Bachelor of Science from Indiana University and a Master of Business Administration (MBA) from George Washington University. He is a NAPFA Registered Financial Advisor and holds the CERTIFIED FINANCIAL PLANNER™ and Certified Exit Planning Advisor (CEPA) designations. Committed to staying at the forefront of his field, he is actively involved with the Exit Planning Institute, National Association of Personal Financial Advisors, and the Estate Planning Council of Indianapolis. Since 1997, Matt has been involved in the investment and wealth management realm, with experience at Charles Schwab & Co., Inc., as well as a boutique Indianapolis-based independent advisory firm and a brief stint at his family’s closely held business.
Outside the professional realm, Matt serves his Indianapolis community by volunteering for Meals on Wheels of Hamilton County and is on the Executive Leadership Team for the Indiana Alzheimer’s Association’s Walk to End Alzheimer’s. He is dedicated to financial stewardship and continuous growth, with an unyielding commitment to enhancing the lives of both his clients and his community. Matt and his wife, Kimberly, reside in Carmel, IN, with their four children, who are all pursuing their college dreams. When he’s not working, he enjoys traveling, reading, and spending time at his lake house in southern Indiana with family. To learn more about Matt, connect with him on LinkedIn.
