Share Article

And Strategies to Help Diversify Your Portfolio

In our roles at Creative Planning, we often work with investors who have accumulated significant wealth through the growth of one or a few individual stocks. Their most common question is, “Should I continue to hold this stock, or sell?” The answer often depends on whether or not the stock represents a concentrated position.

What is a concentrated stock position?

A concentrated stock position is an investment that represents a significant percentage of an investor’s overall portfolio. There is no set dollar amount that defines a concentrated position, as the percentage will vary based on the portfolio’s size. For example, if you have a $3 million portfolio and want to buy a $10,000 interest in a start-up company, this investment would not be viewed as a concentrated position. However, if your portfolio is valued at $50,000, a $10,000 investment would be considered a concentrated position because it represents a significant percentage of your overall assets.

How does someone end up with a concentrated stock position?

There are several ways an investor may end up with a concentrated stock position. As in the example above, an investor may choose to over allocate to a specific stock, betting on big returns. There are also other, less obvious ways investors can find themselves concentrated in a particular holding.

  1. Company stock – Some employers offer company stock or stock options as part of an overall compensation plan. Others allow employees to purchase stock at a reduced price. Over time, these stock positions can add up to comprise a significant percentage of your portfolio.
  2. Inheritance – You may receive concentrated holdings as part of an inheritance of in-kind shares.
  3. Business sale – If your business is purchased by a public company, you may receive compensation in the form of publicly traded shares of the purchasing firm.
  4. Tremendous growth – Some investors have the insight to purchase stock in rapidly growing companies at a very low price. (Think Apple in 2007/2008.) If you’ve experienced tremendous growth over time, these holdings may represent a significant percentage of your portfolio.

The risks of holding a concentrated stock position

If you’ve been investing long enough, you’re likely familiar with infamous story of Enron’s stock. In 2001, many employees who held concentrated positions lost all of their retirement savings when the company’s stock value tanked following the company’s disclosure of serious financial problems. As a result of the scandal, more than 4,500 employees lost their jobs, their income and their benefits, in addition to their life savings.1 While this is an extreme example, it’s a good reminder of the importance of diversifying your investments and income whenever possible.

Behavioral biases play a role

Most financial advisors preach the wisdom of portfolio diversification. Having a concentrated stock position can put you at significant risk in an unexpected situation. Yet, there are several behavioral biases that can prevent investors from diversifying their holdings, including:

  1. Recency bias – This is the tendency to believe that recent trends will continue into the future. For example, the belief that because Apple stock has performed well since 2008, it will continue to perform well long into the future. This bias exists even with investors who understand that companies face the threat of constant competition and industry disruption that can cause unexpected drops in a stock’s value.
  2. Familiarity bias – Investors are more likely to invest in companies that are well known to them. For example, if you use Apple’s products, you may be more likely to invest in its stock, regar