Wealth Planning
Your concentrated holdings: Do you really need to diversify?
Discover how much of one stock you might hold—and still stay on track to reach your long-term goals.
Today’s market volatility has some investors wondering if they are a little too concentrated in some positions. It can be unnerving to watch stock values rollercoaster—especially when, since the start of 2021, a staggering one in 10 companies in the Russell 3000 Index has suffered a 70% drawdown from which it’s yet to recover.1
A look at your concentrated holdings may be advisable. Our research consistently finds that concentrated positions historically have been both the great creator and destroyer of fortunes.2
However, in our view applying simple solutions to any concentrations you have might not always be the best approach.
A widely accepted rule of thumb claims that a properly diversified portfolio must have no more than 10 to 20 percent of total investment assets in a particular stock. But reality is usually more complicated. Certainly, standardized percentage-based rules never made sense for many investors, especially the top executives and owners of public and private businesses who cannot help but have significant holdings in their companies.
Instead, we find it helpful to take a nuanced approach to help clients find their “numbers.” Your acceptable level of concentration will depend on your circumstances, objectives and tolerance for risk. A complete conversation is recommended.
Here, though, we can describe the general framework we use to help clients determine how much diversification they might need to achieve their goals.
Step 1: Identify why you hold a concentrated stock position
There are many paths that lead people into a concentrated position.
Perhaps you are employed by the company whose stock you hold and there are limits to diversifying (e.g., company mandates and/or public perception).
Or maybe the root cause is a sense of control: Because you work at (or own) the company, you feel you understand it best and can have the most impact on its prospects?
We find many clients are simply waiting for their stocks to hit specific price targets. Especially in volatile times, it can feel difficult to sell a position for less than it was worth just a few weeks ago. Are you waiting for a rebound to prior highs?
Step 2: Assess your circumstances
Take a thorough look at your full financial picture so that you can be clear about how important diversification might be for your long-term fiscal health.
Which category best describes your situation?
1. Protected—You could lose your entire concentrated position tomorrow and still be able to support your current lifestyle and long-term goals
2. Vulnerable—You need a portion of your concentrated position if you are going to stay on track to achieve your long-term goals
It’s obviously reassuring to see proof that you are in the “protected” category, and to identify precisely how much downside you might absorb before your lifestyle is affected. Such knowledge can also help give you the confidence that if your stock values hold steady or improve, you might be able to dream bigger and start implementing a variety of planning techniques to achieve these new goals.
If you find yourself in the “vulnerable” category (and even many of our wealthiest clients do), it can be helpful to tally what you are trying to achieve and back into the minimum amount you’d need to diversify to achieve these goals. This is your “minimum dose of diversification” benchmark.
Then we suggest shifting your focus.
Rather than looking at how much of your portfolio is in the concentrated position, we suggest evaluating how much (and which parts) of your future might be at risk due to your concentration.
This exercise is often empowering because it lets you see your target number and assess all potential fixes, given your earning capacity, potential stock performances, spending and goals.
For example: Imagine an investor has a $100MM balance sheet, but $50MM is in a single stock. Obviously, she is concentrated by standard definitions. However, if she is 50 years old and spends $1MM/year, she should be able to sleep at night knowing that her entire concentration could zero out tomorrow and her lifestyle would not be impacted.
However, if that same person spends $1.5MM/year, the concentrated stock’s performance would be crucial to sustaining her current lifestyle.
Lifestyle spending is a vital factor in assessing your vulnerability
Assume a 50-year-old has $100MM net worth with $50MM in a concentrated position and $50MM in diversified assets*
Step 3: Free yourself to find your best path
If all this assessing sounds like going for the medical exam you know you need but would rather not schedule, here are a few scientifically backed thought exercises that could liberate you:
- Imagine it’s not yours—Pretend these investments belong to your friend James, and he asks you to give him financial advice. “Is this a good use of my capital? Does this look like a smart idea? Am I too concentrated?” What would you tell him?
- Start from now—Imagine you don’t own your concentrated holding, but are instead presented with the opportunity, right now, to buy the entire position at a price exactly equal to however much you have invested. Would it be a good investment for your goals?
- Regain control—In holding on to a concentrated position, we’re actually not exercising control, but rather relinquishing it. We’re sitting back, waiting for circumstances to dictate our options. Real control comes from creating a strategic plan for our wealth.
- Remember your goals—Why are you investing your money? What is the intention of your wealth? It’s rare that we want a specific number of shares in a specific company or industry. Few set out to have X percent of ABC Company. Instead, we want what that investment, that wealth, might provide. So ask yourself: Does this consolidated positions help you pursue these desires? Or is there a better way?
We can help
Your concentration may be both an opportunity and a risk. But only by sizing that potential risk and what it may mean for you and your family, can you begin to choose from among the many solutions that might be available.
Speak to your J.P. Morgan team about having your concentration risk assessed. Turn any concern about volatile markets you might have today into a chance to chart an even better path to achieving your financial goals over the long term.
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