Concentration

Answer: It’s crazy, right? How can the same thing that created your wealth be a potential threat? Owning a significant amount in a successful company can be incredibly profitable, yet at the same time, your financial future may be tied to its performance. Even if all is favorable at the moment, diversifying a concentrated position may be prudent and benefit your overall wealth position. 

A rule of thumb is that if a single stock is 10% to 20% of a portfolio, that position is overconcentrated. This could happen for several reasons: the sale of a closely held business for shares of a publicly traded company, employer stock incentives, inheritance of a significant position in a single stock, or long-term fundamental investing. 

No matter how overconcentration occurred, the risks are the same. There is the fundamental risk of underperformance. If the shares are in the stock of your employer (or previous employer if retired), much of your financial future may be tied to that company, including your paycheck, retirement account, health insurance, and other benefits, making a dip in stock price feel like a Maalox® moment. However, understand that diversification and asset allocation do not guarantee a profit or protect against a loss. 

When assessing concentration risk, ask yourself key questions: If you were constructing your portfolio today, would you invest the same amount of cash in that company? What impact would a significant drop in the stock price have on your current and future lifestyle? If dividends were reduced or eliminated, how would this affect your cash flow? What factors drive the company’s price? Would a decline in the stock price hurt your long-term financial goals? If the answers create uncertainty or more questions, it may be time to consider strategies for potentially minimizing the impacts of a concentrated position.

Management

Selling a portion of the position isn’t always the only answer when addressing potential downside risk. If you’re an executive or board member with control of stock as a corporate leader, you may be an insider and subject to regulations and company policies governing when and how you may transact company shares, and some of these strategies may be prohibited altogether. There are specific reporting requirements, so it’s important to know the potential impact of public disclosure as well.

Monetization

If you’d like a cash infusion alongside risk mitigation, monetization strategies include outright sales and margin lending. A Margin account may not be suitable for all investors. Borrowing on Margin and using securities as collateral may involve a high degree of risk including unintended tax consequences and the possible need to sell your holdings, which may lead to a significant impact on long-term investment goals.

If managing taxes is a priority while diversifying out of a position, you can explore techniques that employ completion portfolios and equity exchange funds.

Charitable inclinations and donations may help you manage diversification. Strategies such as trusts, donor advised funds, or outright gifts can help reduce your risk and satisfy your philanthropic goals.

Some of these approaches have barriers in the form of legal, contractual, and corporate requirements affecting the sale of restricted or control stock. Also, tax impacts related to capital gains and charitable giving, or emotional attachment, often driven by professional loyalty and behavioral biases like overconfidence, mental accounting, and price anchoring influence decisions should be considered.

Assessing and acting on overconcentration risk highlights the need to discuss all the implications with your entire financial team, including your CERTIFIED FINANCIAL PLANNER® professional, CPA, and attorney, prior to making investment decisions. Stay focused and plan accordingly. 

Raymond James does not provide tax or legal advice. Please discuss these matters with the appropriate professional. 

Opinions expressed are those of the writer as of April 13, 2025, but not necessarily those of Raymond James & Associates, and subject to change at any time based on market conditions and other factors. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and investors may incur a profit or a loss.