The Market’s Reminder: Single-Stock Concentration Is a Concern

Sooooo … perhaps you have heard, a very large company’s stock is enduring a rough patch, due in part to some CEO turnover. This article isn’t about that. MarketMinder doesn’t make individual security recommendations, after all. But the news does present a timely reminder: Loading up on any one stock is a risk.

It is also an easy risk to back into if the company in question is your employer. Publicly traded companies often have employee purchase plans letting workers buy at a discount. They may also have stock-based compensation. This is particularly common in Tech. These things are fine, good even. They let employees participate directly in the company’s growth in ways salary alone wouldn’t. Salary doesn’t compound exponentially the way stocks can.

But this introduces risks. If you participate diligently in an employee purchase plan and/or receive stock as compensation, and this stock appreciates wildly, you can end up having a very large chunk of your savings in a single stock. And if it is tucked away in your 401(k), it may not be front-of-mind. You may have your investments auto-allocated. You might not check in often. You might take great pains to diversify your IRAs and other investment accounts but think of your 401(k) as something to tackle later, once you retire.

If any of this hits home, if you have a big pile of your employer’s or any single company’s stock, we suggest sitting up and considering the big risk you are taking. You are putting your financial future in the hands of a single company, and its fortunes are outside your control. When it does well, it can feel great. But a rough patch can be a severe setback.

While we aren’t comparing the current story’s specifics to 2001, Enron employees learned this the hard way 25 years ago. The company famously matched 401(k) contributions with company stock and encouraged employees to buy even more. A Department of Homeland Security post-mortem found two-thirds of the 401(k) plan’s assets were in company stock.^[i] When Enron failed, employees’ retirement security was wiped out. Today, we doubt the story’s central company fails. But weakness in a concentrated position can still hurt.

We understand the temptation to load up on your company’s stock. Investors have a huge bias toward companies they know. What company could you know better than your employer? You know the business model inside and out. You know the challenges and opportunities. You know the executives. You know how hard you and your colleagues work and how much better you are than the competition. You know the industry and its long-term prospects.

The problem is, all of these things are widely known, and markets price them efficiently. Meanwhile, there will always be things you don’t know. There will be things outside your control. Problems may be brewing in other departments that you aren’t aware of until it is too late. Executives who present well publicly may troubled behind the scenes. A competitor may have a jump on a new technology. Some regulatory headwinds may be building from outside your company’s walls. And when the market sours, it can sour fast.

So if you have a large slug of your portfolio in any single stock—a significantly bigger slice than your company’s share of the S&P 500 or MSCI World—look to diversify. No matter how bullish you are on the company, no matter how well it has performed, no matter how well you think you know it. Overconcentration is a tremendous risk. Diversifying may not seem as exciting, but it cuts company-specific risk while widening your opportunity set. Tax issues? Plan for them. But make sure that plan is a clear path to diversifying.

You may have heard the old saw, concentrate to build wealth, diversify to preserve it. Politely, respectfully, this is hogwash. That is needle-in-a-haystack talk. What if you concentrate in a stock that tanks? Or goes sideways amid a broad bull market? Plenty of people work for solid, successful companies whose stock prices don’t go parabolic in a few years. The success stories loom large, but they are the exception, not the rule. If you have been blessed to reap big returns from your employer’s stock, give thanks and diversify now, and know that this isn’t a reliably repeatable success.

Diversification is still a marvelous way to build wealth. If you allocate across sectors and major regions, you can generally harness the market’s long-term compound growth. It is the slower but steadier path even with stocks’ innate volatility and some bear markets along the way. Time, patience and discipline bring the real rewards.