Given recent bouts of market volatility, some investors are left wondering if they are a little too concentrated in certain positions. In this type of market environment, a look at your concentrated holdings may be advisable. Our research consistently finds that concentrated positions historically have been both a great creator and destroyer of fortunes 1
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 advise against automatically applying a simple solution to any concentrations you may have. We find it helpful to take a nuanced approach to help clients find their “number.” 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.
Ever looked at those Apple or Nvidia stock charts and thought, “Man, if only I’d bought those years ago”? Yeah, me too. It’s tempting to think we could spot the next big winner. But here’s the hard truth – single stocks are risky business, and understanding why might just save your financial future.
At J.P. Morgan Private Bank, we’ve seen concentrated positions be both incredible wealth creators and devastating wealth destroyers. This dual nature makes single stock investing something that requires careful consideration, not just blind optimism.
The Volatility Rollercoaster of Individual Stocks
Individual stocks tend to experience greater price swings (higher highs and lower lows) than diversified investments Their values can fluctuate based on individual company news and economic or market news This volatility isn’t just an abstract concept – it directly affects your wealth and potentially your future,
When you invest in a single company, you’re essentially putting your financial eggs in one basket. And that basket might look sturdy until:
- The company announces disappointing earnings
- A key executive suddenly resigns
- A competitor releases a game-changing product
- Regulatory changes impact the business model
- Industry disruption makes their product obsolete
Any of these events can send a stock plummeting, sometimes overnight. Unlike a diversified portfolio where these risks are spread across many companies, sectors, and sometimes countries, single stock investors feel the full impact of these swings.
Concentration Risk: The Silent Wealth Killer
A widely accepted rule suggests that a properly diversified portfolio should have no more than 10-20% invested in any particular stock. Yet many investors especially company executives and business owners find themselves far more concentrated.
Why is this so dangerous? Let me break it down:
The Protected vs. Vulnerable Reality Check
When evaluating concentration risk, J.P. Morgan Private Bank recommends assessing if you’re:
- Protected – Could you lose your entire concentrated position tomorrow and still support your current lifestyle and long-term goals?
- Vulnerable – Do you need at least a portion of your concentrated position to achieve your long-term goals?
Imagine an investor with a $100 million balance sheet where $50 million is in a single stock. If they spend $1 million annually, they’re likely protected – even if the stock went to zero, their lifestyle remains unaffected. But if that same person spends $2 million yearly, they’d become dependent on that stock’s performance to maintain their lifestyle.
Now scale this down to more typical numbers – the same principles apply whether we’re talking about millions or thousands.
The Emotional Factor: Your Worst Enemy
I’ve seen this countless times – investing isn’t purely logical. Emotions often drive decision-making, and single stocks amplify these reactions. When your retirement depends on one company’s performance, watching that stock drop 30% isn’t just a number on a screen – it’s years of dreams potentially vanishing.
This emotional rollercoaster leads to predictable but devastating behaviors:
- Panic selling at market bottoms
- Overconfidence during bull markets
- Confirmation bias when researching (only seeing information that confirms what we want to believe)
- Loss aversion making us hold losing positions too long
A diversified portfolio helps smooth these emotional triggers. When one sector drops, others might rise, making it easier to maintain investment discipline.
The Practical Dangers of Single Stock Risk
Timing Gets Trickier
With individual stocks, you need to know both when to get in AND when to get out – preferably before everyone else figures it out. This is nearly impossible to do consistently, even for professional investors.
As the Bible reminds us, cycles are inevitable and normal (2 Peter 3:4). Markets go up and down. The question isn’t if volatility will happen, but how we’ll respond when it does.
Tax Complications
While single stocks can offer some tax advantages (like control over when to realize capital gains), they also create potential tax headaches:
- Large positions may be difficult to unwind without triggering significant capital gains
- Concentrated positions might limit tax-loss harvesting opportunities
- Emotional decision-making can lead to poor tax timing
Real-World Impacts
When it comes time to need your money, the last thing you want is for it not to be there. Single stock concentration means your retirement, your kids’ education fund, or your dream home purchase might depend on one company’s performance during the specific timeframe when you need the money.
Finding Balance: When Single Stocks Might Make Sense
Despite these risks, there are situations where holding individual stocks might be appropriate:
- As a limited portion of a broader diversified portfolio (typically 5-10% maximum)
- When you have specialized knowledge of a specific industry or company
- For non-essential “satellite” investments separate from your core financial security
Cooke Wealth Management suggests that while individual stocks carry higher risk, they can complement a diversified portfolio for some investors. The key is limiting exposure and avoiding using funds that are essential to your financial security.
Practical Strategies for Those With Concentrated Positions
If you’re currently holding a concentrated position, consider these approaches:
Step 1: Identify Why You Hold the Position
Many investors maintain concentrated positions due to:
- Employment restrictions
- Feeling of control (especially if you work at the company)
- Waiting for a specific price target
- Emotional attachment
Understanding your reasoning helps develop an appropriate strategy.
Step 2: Use the “Friend Test”
Imagine it’s not your money but your friend’s. Would you advise them to keep such a concentrated position? This mental distance often provides clarity.
Step 3: The “Start From Now” Exercise
If you didn’t already own the position, would you buy it today with the same amount of money? If not, that’s a strong signal.
Step 4: Remember Your Goals
Why are you investing? Few people set out to own X% of a specific company. Instead, we want what that wealth provides – security, opportunities, legacy. Does your concentration support those goals, or is there a better way?
The Power of Diversification
Diversification remains one of the most powerful risk management tools available to investors. By spreading investments across different companies, sectors, and asset classes, you can reduce the impact of poor performance from any single investment.
This doesn’t mean eliminating all individual stocks – it means being strategic about their role in your overall financial plan.
Single stocks do carry high risk – that’s an undeniable fact. Their price swings can be dramatic, concentration creates vulnerability, and emotional decision-making becomes amplified.
But understanding these risks doesn’t mean avoiding stocks altogether. It means approaching them with eyes wide open and a strategic plan that considers:
- Your personal financial goals
- Your risk tolerance
- Your overall investment timeframe
- How each position fits into your broader portfolio
At Cooke Wealth Management, we believe investing should be purposeful, disciplined, and aligned with your values. Whether you’re managing a concentrated position or considering adding individual stocks to your portfolio, the key is understanding both the opportunities and the risks.
Single stocks may be risky, but with proper planning, education, and sometimes professional guidance, these risks can be managed as part of a comprehensive investment strategy.
Have you checked your portfolio lately to see if you’re too concentrated in any one position? It might be time for a review.
Lifestyle spending is a vital factor in assessing your vulnerability
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 belonged 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 were 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 onto 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: Do these concentrated positions help you pursue these desires? Or is there a better way?
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 identify precisely how much downside you might absorb before your lifestyle is affected. Such knowledge also can help give you 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), we recommend tallying what you are trying to achieve and backing into an appropriate amount of your concentration 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 balance sheet 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 have comfort knowing that her entire concentration could zero out tomorrow but her lifestyle would not be impacted.
However, if that same person spent $2MM/year, the concentrated stock’s performance would be crucial to sustaining her current lifestyle.
Why Do Single Stocks Carry A High Degree Of Risk? – AssetsandOpportunity.org
FAQ
Why are single stocks riskier than mutual funds?
Higher risk: Investing in single stocks can be riskier than mutual funds, as the value of a single stock can be impacted by company-specific factors such as management changes, product failures, or legal issues.
Why are shares so high risk?
Stocks are much more variable (or volatile) because they depend on the performance of the company. Thus, they are much riskier than bonds. When you buy a stock, it is hard to estimate what return you will receive over time (if any).
Why shouldn’t you invest in single stocks?
- #1: It takes a lot of time, expertise, and objectivity.
- #2. It costs more.
- #3. There’s a greater risk of loss.