Concentrated stock positions — holding a significant portion of one’s portfolio in a single stock or a few stocks—can present a number of risks to your portfolio. 

These positions often arise from circumstances like founding or inheriting a company, equity compensation from employment, or a strategic investment in a particular sector. While having a large position in one stock could be considered a good problem to have, it could be a problem nonetheless. 

Here’s an overview of the associated risks and strategies to manage those risks:

According to a blog post by Jeremy Milleson, Director of Investment Strategy at from Parametric Portfolio, in five year rolling periods spanning 2000 to 2021, the value of every single stock in the S&P 500 dropped by at least 20%; and 63% of them tumbled by 40% or more. 

Risks of Concentrated Stock Positions

1. Lack of Diversification

Concentrated positions violate one of the core principles of investing: diversification. If the stock underperforms or collapses, the investor’s portfolio can suffer catastrophic losses. 

https://advisoranalyst.com/2014/06/26/diversification-never-make-a-killing-never-get-killed.html/

2. Market and Company-Specific Risks

A concentrated position exposes the investor to risks tied to the company’s specific performance, such as competitive pressures, regulatory changes, or economic downturns. 

Even a strong company can face unexpected challenges. 

Since Alphabet (Google) dominates the search market by obtaining over 90% of search traffic, they are often under scrutiny for being a monopoly. While they have largely avoided major changes to their business to date there is always a risk that the government might force them to break up the company. 

3. Volatility

Stocks, especially individual ones, are inherently more volatile than diversified portfolios. This volatility can lead to emotional decision-making, such as selling during a dip out of panic.  

4. Liquidity Constraints

Large positions may be difficult to sell without impacting the stock price, especially for investors in less-liquid markets or stocks with lower trading volumes. 

If you happen to own a large stock position in a smaller company your efforts to sell a significant portion of your shares could drive the price down. 

5. Tax Implications of Diversifying

Reducing a concentrated position by selling shares can result in substantial capital gains taxes, especially if the shares have appreciated significantly. There is only one thing worse than having to pay taxes and that’s not having to pay taxes because a position took a loss. Oftentimes holding a large individual stock position that continues to grow over time can exacerbate the potential tax consequences if there is a need to sell that was unplanned. 

6. Opportunity Cost

By tying up capital in one position, investors may miss other opportunities for growth in different sectors or asset classes. This sometimes happens when an investor inherits a stock from a relative and feels they should hold onto it for sentimental reasons. Or an investor works for a company and feels that the have a lot of information on their employers stock and therefore feels more comfortable holding it than taking on other positions that they have less knowledge about. 

Strategies to Manage Concentrated Stock Positions

Investors with concentrated positions can take steps to balance the risks and opportunities:

1. Gradual Diversification

Sell shares incrementally over time to spread out the tax burden and reduce market timing risks. 

One strategy is to decide how much to sell over a period of years to stretch out the tax burden. For example, “I am going to reduce my position in XYZ  by selling 25 % of my shares every January.” 

2. Hedging

Use tools like options or exchange funds to hedge against downside risks while retaining ownership. 

3. Charitable Donations

Donating shares can provide a tax deduction while also allowing for diversification of the remaining portfolio. This is one of my favorite strategies because the investor reduces the number of shares they have, often gets a tax deduction, doesn’t have to pay any capital gain taxes on the shares they donate and the charity usually doesn’t pay any taxes on the donated shares when they sell the shares. 

It’s a very effective way to reduce the number of shares and make a donation at the same time. 

4. Structured Sales

Employ tactics like a 10b5-1 plan, which allows executives and insiders to sell stocks in a pre-planned manner, reducing the perception of insider trading.

5. Borrowing Against Shares

Some investors choose to leverage the value of their stock as collateral for loans, avoiding immediate tax consequences while maintaining their position. 

Ever wonder why some wealthy people don’t seem to pay much in taxes in proportion to their overall wealth? 

This might be one of the reasons. Many wealthy investors just borrow against their shares to meet any income needs rather than sell some of their shares and have to pay capital gains taxes. 

Balancing the rewards and challenges of concentrated stock positions requires careful planning and consultation with financial, tax, and legal advisors. 

While these positions hold transformative potential, managing the associated risks is critical to ensuring long-term financial stability.