Managing Concentrated Stock Risk

Discussions of concentrated stock positions often nervously reduce to the adage: Concentrations can make you a killing, or get you killed. For those that find themselves in concentrated positions today, an attractive middle ground exists, balancing upside and wealth preservation.

How did we get here?

Concentrated positions are commonly accumulated through corporate equity compensation, or by purchasing a single stock ahead of a hyper-growth cycle. Accumulation through equity compensation tends to impact a limited group of executives and follow a more predictable path. Accumulation through hyper-growth applies more broadly and unexpectedly. For example, consider early investors in companies like Apple, Tesla, or Nvidia.

Risk Associated with Concentration

Holding concentrated positions is not necessarily bad, but it is risky. Individual stocks are far more volatile than diversified portfolios. Pricing moves of large single stock positions will have an outsized impact on the broader portfolio – upside scenarios can drive significant wealth, while downside results can meaningfully erode financial security. Environmental risks that are weathered by the broader market, can be detrimental to single companies. For example, shifts in governmental oversight and enforcement (anti-trust) or policy changes (tariffs) can significantly impair a specific company, as can disruption due to technological innovation or geopolitical conflict. Company specific risks also apply, such as the loss of a key customer or supplier, product specific issues, or distribution problems. Employee fraud and ensuing crisis of confidence can temporarily shake a market, while simultaneously bankrupting a single company (Enron).

Large single stock positions often build as investors are reluctant to sell due to emotional attachment or perceived tax consequences. Reasoning that selling equates to losing out on continued growth, plus the tax expense of gains often fuels continued risk taking. This bias presumes the past pace of growth will continue and ignores the benefit of capturing profits and the taxable realities of doing so.

Am I at Risk?

What it means to be concentrated and the ability to absorb the risk is unique to each individual situation. The first step is assessing your ability to absorb the risk associated with single stock exposure. One approach is to carve out assets by need. The first bucket of assets is to cover your lifestyle/spending/retirement needs. The next bucket represents the minimum goal to leave to heirs. The final bucket is surplus. For purely surplus assets, ranging outcomes would not impact the primary lifestyle or legacy objectives, whether the position doubles in value or goes to zero.

If you plan to rely on concentrated positions for your primary goals, then risk should be tempered.

Addressing Risk

Once establishing that unacceptable exposure exists, several strategies can be applied to manage concentration and decumulate excessive risk.

• Sell the stock, lock in the profits, and pay the tax. Depending on the individual situation, this can be appropriately executed at once, or follow a balanced approach. Pricing upside can be captured strategically by establishing price targets for decumulation at certain pre-determined marks. “Sell X-amount of shares, at Y-price.” This disciplined profit taking approach helps remove emotion from the decision-making process.
• Hedge your risk. Applying hedging or collar strategies using options to manage downside risk without selling the position.
• Optimize tax consequences of decumulation and thoughtful income recognition as part of the plan. For example, selling over a period of years to minimize taxes or by utilizing a charitable remainder trust vehicle to sell/diversify holdings while mitigating the associated tax cost.
• Evaluate the impact of layering strategies to meet multiple objectives. For example, donation of stock reduces concentration, and addresses charitable giving objectives, while also reducing tax cost.

If it feels like your concentrated stock made a killing already, consider it might be time to rethink your position. Please contact your JMG advisor with any questions that you might have. We invite you to share this article with others who may also find it helpful.

Important Disclosure

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