Sunday, September 20, 2020

Too Much of a Good Thing?

 

 

Ask The CFP® Practitioner
Darcie Guerin
darcie.guerin@raymondjames.com

“We can be sure that the greatest hope for maintaining equilibrium in the face of any situation rests within ourselves.”
Francis J. Braceland, former U.S. Surgeon General 

Question: My portfolio contains a fair amount of stock in the company I retired from. One of my children still works for the same company. What are your thoughts on how much is too much to have invested in one company?

Answer: The situation you’re describing is referred to as a concentrated equity position. This is generally defined as any single holding that’s three or more times larger than an average position in a portfolio, or more than ten percent of an investor’s net worth. There is no specific legal definition but there are guidelines. In the institutional world concentrated positions are rarely permissible because they’re so risky and can be considered to be a breach of fiduciary duty if present in a portfolio.

Asking the question indicates that you’re aware of the risk. Having an overconcentration creates a potential lightning rod attracting unnecessary risk. Usually these positions start as smaller holdings due to stock and option incentives from an employer, the sale of a private company in exchange for shares of a publically traded corporation, or simply due to share price appreciation.

Unfortunately we’ve seen catastrophic effects to entire family’s financial security with these situations. Many of the “dot.com” companies, Eastman Kodak, Firestone, General Motors, Bear Stearns, Lehman Brothers and defunct banks are examples of how holding a large, single stock position can pose significant risk. If employed by that company risk may be doubled if there are problems; not only could the stock value drop, a paycheck may be in jeopardy. One reason we invest is to avoid uncertainty, thereby making concentrated positions a counter-intuitive practice.

Mitigating Risk

Diversification may reduce a portfolio’s overall volatility. Presumably, holding a variety of stocks and bonds reduces risk by spreading it from one stock to multiple sectors and asset classes. This may reduce instability in a portfolio, thereby lessening the impact of any one stock on your overall portfolio.

Some reasons investors may sidestep diversifying are the potential tax implications of selling and taking capital gains, loss of dividend income, emotional attachments and/or behavioral biases. Emotions also influence investors in many ways, most often showing up as either overconfidence or fear. These concerns may paralyze and immobilize investors preventing them from taking necessary actions to diversify.

Selling stock isn’t the only way to reduce the amount held in one position, there are other strategies and techniques to lessen the impact of a concentrated position. Tax-efficient gifting is one of the simplest examples. There are more complex techniques to explore, which may or may not be appropriate from a tax-planning and legal perspective. Implementing a single strategy or combining techniques to potentially reduce the

Submitted Photo

Submitted Photo

risks associated with concentrated holdings may be the solution.

Working with a team of trusted financial professionals including a CERTIFIED FINANCIAL PLANNER PRACTITIONERTM, tax professional and attorney who have expertise in this area may help you determine what’s appropriate for your individual circumstances. Discuss your situation, goals and concerns and match recommendations with your objectives clarifying what solutions may be plausible.

The Power of Example

The best way to pass on wealth, financial literacy and knowledge is by example. Good habits are bequeathed to children and young adults who have positive money-wise role models in their lives. Regrettably, unhealthy and risky money management techniques are mirrored as well.

Although estate planning and the use of legal documents such as trusts and wills can help ensure that your wishes are carried out, it’s just as important to pass along values and attitudes. One of those principles may be risk reduction by limiting overexposure to one company, especially if there’s an emotional tie to a company.

All too often heirs receive an inheritance that includes one or two companies that a spouse, parent or other family member has held for years. There may be an unwillingness to sell the stock for no other reason than that it represents a tie to the individual who has passed, overlooking whether or not the investment is suitable or matches their current situations and needs.

Eyes Wide Open

There may be reasons why it could be beneficial to hold an overconcentration in a single position, yet it’s wise to be aware of the potential risk. A substantial decline in market value could significantly reduce your net worth. Decide if you’re comfortable maintaining the security at a certain level and discuss diversification strategies with your team of trusted financial advisors if you’d like to reduce the existing exposure of this position. Stay focused and plan accordingly.

Investing involves risk including the possible loss of capital. There is no assurance that any investment strategy will be successful. Asset allocation and diversification do not guarantee a profit nor protect against loss. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. As federal and state tax rules are subject to frequent changes, you should consult with a qualified tax advisor prior to making any investment decision. 

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.” 

This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc., Member New York Stock Exchange/SIPC, 606 Bald Eagle Dr., Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email darcie.guerin@raymondjames.com. Website: www.raymondjames.com/Darcie.

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