Concentrated Holdings Have No Place in a Portfolio


Posted in: Economics, General, Stock Market, Thought of the Week

A world-renowned company emerged as a true Wall Street darling during the 1990s. This firm had a reputation for hiring the best and brightest, outmaneuvering their competition in highly profitable markets, and making their employees and investors a lot of money. This company paid huge bonuses to top producers, which were often in the form of company stock. Since the stock price surged over this time period, employees gleefully watched their net worth skyrocket, and many became multimillionaires well before their 30th birthday.

As the stock continued its meteoric rise, several employees saw no reason to sell any stock for two key reasons:

  1. Management: The leaders of the firm urged employees to keep their entire 401k and other investment vehicles in as much company stock as they could own because the prospects of the firm were so bright. Employees were also hesitant to send any signal that they would ever doubt management’s bullish tone.
  2. Employees Had an Edge: Employees often prefer to own the stock of their employer because they believe that they have an “edge” over other investors, since they are closer to the day-to-day operations of the firm.

Wall Street was also enamored with management because they consistently beat even the most aggressive earnings forecast. Given the wealth created, it’s easy to see why many investors succumbed to the powers of greed. Employees and investors alike became so addicted to the stock performance that they ignored the most basic principles of diversification by allocating their entire investment account to this one stock.

Unfortunately, this company’s name was Enron. In a matter of weeks the stock price went from $90 to a few cents. Those who felt that they had an “edge” or listened to management’s fairy tale walked away with an empty 401k and unemployed. These victims should not be faulted for failing to recognize the fraudulent activity. Detecting fraud is incredibly difficult since so few culprits are involved. Rather, their mistake was putting way too many eggs into one basket, and they paid the price. Simply put, Enron is a great example of why investors must maintain strict diversification at all times.

Investors often accumulate a concentrated holding for a number of reasons. These positions typically develop over time, and it’s safe to say that accumulating a concentrated holding is a great problem to have in a portfolio. However, as this position rises relative to the overall size of the portfolio, the risk quickly outweighs any potential for future gain. Always remember that the goal of investing is to manage risk, not take risk, and keeping any one position higher than 20% of your investible assets is strongly discouraged.

There are instances when an investor is forced to maintain a concentrated position. For example, managers are often required to hold stock for a specific time period, while others fear that selling a stock would lead outside investors to believe that future prospects for the firm are dire. Fortunately, strategies exist for those who cannot sell but still want to mitigate the risk inherent in concentrated holdings. Our Investment Committee strongly urges anyone holding a concentrated position to consult his or her financial advisor to begin the necessary steps to shield your portfolio. There is no excuse for exposing a portfolio to unnecessary risk, and concentrated holdings should be eliminated or hedged at all times.

Read this week’s Thought of the Week to learn more about mitigating risk with concentrated holdings.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.