Why Diversify Your Concentrated Stock Portfolio
When people talk about the stock market, they often talk about the big names like Apple, Amazon, or Google. Whether they’re up or down and the reasons behind the change make headlines, so when it’s time to invest, they seem like the logical places to start.
But are they?
If you’re an executive, you probably have your company’s stock options in your compensation package. You may have multiple opportunities to buy more of your company’s stock in various sales. It sounds like a no-lose situation.
But is it?
The short answer to these questions is, “maybe.” The key is to ensure you’re leveraging your interests and employer opportunities while considering your overall financial goals. When it comes to your investment portfolio, what’s truly more important is that it’s diversified.
What Is a Concentrated Stock Portfolio?
When a stock portfolio is concentrated, it consists of one company’s stock or one market sector. Your portfolio is concentrated, for example, when you own Apple stocks and nothing else. You may be concentrated by sector. For example, you own only tech stocks. Your investments are concentrated in one area.
Why Do People Have Concentrated Stock Portfolios?
There are a couple of reasons why your portfolio may — intentionally or otherwise — be concentrated. One of the biggest reasons is holding stock of your current employer. Because you’re partially responsible for and believe in your company’s ability to achieve success, you’re naturally inclined to invest in it. Your company offers stock in the form of restricted stock units or stock options, or you have the ability to buy shares at a discount through an Employee Stock Ownership Plan.
Another way portfolios become concentrated is when you manage and buy individual stocks on your own. A prevailing piece of advice when investing in stocks is to buy companies you know and whose products or services you use every day. In addition to individual companies, sometimes people buy in one industry such as technology, healthcare, or telecommunications.
It’s not uncommon for clients to come to us with investment philosophies such as always buy stocks that pay large dividends. This can be great advice. The key is to then refine those philosophies to meet your desired financial goals.
What Are the Risks of Concentrated Stock Portfolios?
When you invest in only one stock or sector, your portfolio lives and dies by that one investment. This can have devastating implications. Your investment goes up or down in value as the organization or sector goes up and down. There are the extreme, headline-making cases such as Enron and Bear Sterns or the dot come bubble of 1995), but more often there are cases where an organization is experiencing a rough period and may need to go through layoffs. When your portfolio is concentrated in the stock of your employer, rough times mean you’re not only worried about your own position but also that of your investment portfolio.
It increases the overall risk profile of your portfolio which could set you back. This is especially important for corporate executives who receive company stock as part of their compensation package or individuals who are closing in on retirement who do not have the time to make up for any lost value in their portfolio.
Owning one or even a handful of stocks can lead to a portfolio that’s riskier compared to a portfolio that’s comprised of thousands of different stocks.
The Benefits of Diversified Investment Portfolios
With a diversified portfolio, your investments aren’t reliant upon one company or sector, so you inherently lower your risk. This isn’t to say you can’t own stocks in a particular sector of interest or even in individual companies — it’s to say we’ll balance out those stocks with others.
Research shows that individuals are more likely to stick with their investment strategy if they can manage their portfolio’s volatility. A diversified portfolio experiences less overall volatility (swings in the market) compared to one comprised of only handful of stocks. This can make riding out the market’s inevitable down-turns more manageable.
Research also shows that time in the market is one of the most impactful factors in generating overall wealth in the long run. Having a diversified portfolio. which experiences less drastic swings than a concentrated portfolio experiences can add value by helping you make fewer emotionally driven decisions.
Believe it or not, a diversified portfolio can also be much easier to manage than a concentrated portfolio. Exchange Traded Funds (ETFs), mutual funds, and professionally managed accounts provide investors with access to hundreds, sometimes thousands, of different companies wrapped into one vehicle. This can make building a portfolio easier because you don’t have to hand select stocks on an individual basis.
As we monitor and manage your diversified portfolios, we’re in position to take advantage of market shifts and tax code changes. We can do this without increasing your overall risk exposure and keeping an eye on your financial health, so we know we’re on track to meet your goals.
For Investors Who Own Company Stock
If you received stock options in your compensation package, buy stock through your Employee Stock Option Program (ESOP), or who have access to purchase your employer’s stock, you’re in a unique position. For instance, you’ll want to ensure you protect yourself from SEC rules through a Rule 10b5-1 Plan.
You’ll also benefit from working with financial fiduciaries who can best advise you when opportunities to modify your stock ownership arise. When you go to a new organization, we can help you take advantage of your benefits packages. There are different ramifications depending on the type of plan you elect, and we can evaluate your options based on your overall financial goals.
You Can Still Buy Individual Stocks
At Capstone, we encourage, enable, and celebrate an interest in investing. Let’s face it — buying individual stocks can be fun. This hands-on approach is a great way to learn about the market’s ups and down, and your own reactions toward risk.
People also buy on emotion. Several studies prove this, and it applies to individual stock purchases. It’s fun! We don’t discourage this kind of investment. We just want to ensure it isn’t the main driver of your accounts.
For our clients who love picking their own stocks, we recommend opening a second account for this purpose. We can help open it, incorporate it in your overall portfolio allocation, and track it.
Disclosures:
This article is not a substitute for personalized advice from Capstone and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed by other businesses and activities of Capstone. Descriptions of Capstone’s process and strategies are based on general practice, and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.