Concentrated positions in your portfolio happen when the value of one stock becomes more than 10% of your overall holdings. It could happen naturally as a company experiences rapid growth and popularity among investors or as a result of a dividend reinvestment plan or intentional stock purchases. Perhaps it is a legacy position that you inherited, or maybe it is just that you love the company that much—from the products, to the CEO, to the stock. Likewise, it has performed so well you haven’t wanted to give up that accelerated growth.
The problem with a concentrated position is that it is not a portfolio—it is one stock, and that can be risky. We’ve seen this happen with investors who work for a company and receive stock as part of their compensation and with investors who buy into a local company that grows into a leading nationwide retailer. It’s not uncommon to see one stock comprise 30% to 50% of an investor’s portfolio. A shift in market sentiment, industry regulation, technology, competition, mismanagement, or scandals could be detrimental to the company resulting in a major impact to your investment. If 50% of your portfolio is in one stock, you could lose half of your invested assets—not many investors could recover from such a blow.
We recommend diversifying your portfolio with at least 10 to 16 different holdings in at least eight of the 11 market sectors. We generally like to see 35-45 stocks and exchange-traded funds in a Large Cap portfolio. Diversifying your holdings allows a portfolio to weather the economic cycles, as many sectors are negatively correlated. When one sector has a downturn, typically, a negatively correlated sector will remain stable or go up.
If you have a concentrated position in an IRA or tax-deferred retirement plan, you and your adviser can develop a plan to sell shares and invest the proceeds into other stocks to diversify your portfolio, generally with no tax implications. However, if your concentrated position is in a taxable account, you must consider the tax impact of selling shares. You and your financial adviser can dollar-cost average out of the position, by selling a set dollar amount over time, spreading the tax impact across several years.
You could also gift shares to your heirs during your lifetime; however, this passes along the original cost basis of the stock. If the position has increased substantially in value, your gift could have unfavorable tax consequences for the recipient, should they sell the stock. If you can afford to hold the concentrated position until your death, your heirs would receive a step-up in basis, minimizing or eliminating the tax impact. However, tax and estate laws are subject to change. If you are charitably inclined, you can give stock shares to qualified charities and avoid capital gains altogether. Charities don’t pay tax, so the donation doesn’t create a problem for them.
If a single stock holding is significant, your financial adviser may recommend using a blind trust or charitable remainder trust, or using options to hedge the position to reduce your concentration.
If you have questions on reducing a concentrated position in your portfolio, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the July 30, 2022 “Henssler Money Talks” episode.