Congratulations! You have struck gold in the lottery of single stock investing, and have landed a big winner that has become a massive holding in your portfolio.
Or maybe you work for a listed company and get paid a portion of your compensation in shares. You have allowed these shares to accumulate over time and perhaps your holding now makes up a (disconcertingly) large percentage of your net worth.
What should you do now? Well you have a couple of options of course, one of which is to just do nothing and leave this large holding in place.
This course of action can be particularly tempting if it is a share that has been a strong performer. “It’s a good company, the stock has always done well for me - why would I sell it?”
Employees of a publicly listed company may also think better of selling the shares that they are granted if they feel that the company is doing great things. After all, shouldn’t they have the inside track on the company’s future prospects better than most?
But whenever I come across anyone in this situation I will always urge them to take steps to reduce their exposure to a disproportionately large holding, and reinvest into a more diversified strategy, for several reasons:
Risk management
The most obvious reason. Bad things happen to individual companies all the time, even great ones. And when they do, the share price gets walloped.
While many great companies recover, more do not and history is littered with companies that experienced catastrophic loss, even from a position of market dominance. Enron is the classic example, there are others.
Risk, by its nature, exists in the shadows. Risk is the danger that we don’t see, rather than the one that we do. Risk is the unexpected.
This being the case, most of the time no amount of perceived insider knowledge can protect us from these kinds of events. Despite how over-confident we may be in our investing acumen.
If you are an employee of a listed company and the shares of that company make up a large proportion of your net worth, you also need to consider that in all likelihood a decent slab of your income comes from the same source. If something were to happen to the business, not only would the share price likely tank but your job and future earnings stream could be at risk too.
In such an event, your savings and investments provide your “financial bulletproof vest” - it must be robust.
2. To improve the probability of good future returns.
Historically stock market returns have come from an extremely narrow band of winners. In 2018, Henrik Bessembinder showed that since 1926 the total returns of the US stock market (the S&P 500) had been generated by 4% of stocks. The rest, collectively, generated returns in line with cash.
Put another way, in order to be confident that we will receive the premium return that investing in equities has historically generated over the long term versus cash, we need to have a sufficient spread to ensure that we will be in the future winners.
By having a large proportion of your money in one holding you don’t have a spread. You have the exact opposite - massive concentration.
The data tell us that if you are investing over any kind of sensible timeframe there is the risk that you not only underperform the market, but might end up worse off than if you were sat in cash.
3. Stress reduction
A couple of years back I met a bloke, let’s call him Steve. Steve had around 90% of his net worth tied up in a single company, a bank that he used to work for. Steve seemingly spent most of his free time on his online investing app looking at the price of this one share. Steve’s wife didn’t seem thrilled by this turn of events.
I have never met anyone in this position who did anything other than watch the share price of that individual stock like a hawk. Days ruined by a 5% drawdown. Sleepless nights before results.
Investing is hard enough, why make it more difficult for yourself by taking on additional risk of making a behavioural mistake?
Endowment bias refers to our propensity to over-value an asset that we own. “Never mind that the market prices these shares at 80p, I’ll sell when they get to a pound.”
Let me tell you for free that one of two things will happen in that scenario. One, the share price never gets to a quid. Or two, it does and you won’t want to sell because the stock is working. In either case, by setting a false exit price (which is always a round number coincidentally) we simply get in our own way.
Good investing, and good financial management frankly, comes from a place of trying to avoid mistakes. And the primary method of avoiding errors is by taking the time to build a plan, in a cold and unemotional environment, that you can execute on even at times of high emotion.
So for those caught in the kind of “over concentrated” situation that I have identified above, a sensible plan may be to:
Sell half of your position immediately; and
Sell the remainder in equal tranches over the following six months.
If you feel strongly, you can keep some of your holding - but absolutely no more than 10% of your overall net worth.
Yes, there may be tax consequences of selling shares held in taxable accounts. But while, for the time being, Capital Gains Tax rates are at worst half of the equivalent income tax rates - this does not feel like a particularly onerous burden to bear.
Paying Capital Gains Tax at 10% or 20% on a profit, as an insurance policy against the risk of catastrophic damage to your financial plan in future doesn’t feel like a terrible trade.
If you follow this kind of plan, or similar, you also need to prepare yourself that the share price may move against you over time. A few months or years down the road, those shares that you sold may have gone up or may have even gone up by a lot. “Damn I wish I had just held on!”.
If this happens, I would say three things to try and make you feel better.
If you make a sound decision that leads to a bad outcome, it was still a sound decision.
There is absolutely no guarantee that you would have stuck around holding the shares for long enough to receive the higher price.
Even if the share price has gone up, has it done as well as the investment that you re-invested the proceeds into or indeed the broad market? In my experience people are pretty terrible at accounting for opportunity costs and/or relative performance.
Ultimately, investing is hard. Short term outcomes are highly unpredictable, and therefore by definition you are going to get a bad outcome occasionally. Fear not, once you are invested in an altogether more sensible strategy the odds of a great outcome grow greater by the day.
Past performance is no guarantee of future returns. None of the above is intended to constitute advice to any individual. If you need help, please seek out assistance from a qualified and regulated financial adviser.
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