# Managing concentrated stocks? Understand the risk and strategies All the little-known ways to manage a highly appreciated stock in your portfolio [Christopher Lange](https://usecache.com/author/christopher-lange) Head of Investments [Srikanth Narayan](https://usecache.com/author/srikanth-narayan) Founder and CEO ## What is portfolio concentration risk? Most investment professionals say that concentration risk exists when more than 10% of your portfolio is tied up in one asset. When this situation arises, your exposure to that asset creates risk because you could potentially suffer significant financial losses if it performs poorly. If you have a concentrated stock position, your portfolio experiences the movement of that stock in an outsized way. The timing of the stock’s upward and downward movements may (or may not) align with your specific investment and monetary needs. As an example, Meta lost 64% of its value in 2022. Its value increased by 149% during the first nine months of 2023. Overall, the stock was down about 13% over that period. As an investor, you have to ask yourself if you are comfortable with the volatility of that investment experience. ## Why is a concentrated position risky? When you’re concentrated in a single stock, several potential risks to your portfolio can start to overlap: - The risks of that particular business - The risks of its industry - The risks to its sector or geographic location - Broad market risks and macroeconomic risks Typically business risks pose the biggest threat, because most businesses are focused on doing one thing well. If a business runs into problems that impact its ability to do that one thing, its outlook can deteriorate quickly. There are a few vulnerabilities that routinely sneak up on a seemingly-strong business. Here they are, along with some examples of some of companies that have been impacted: ### Competitive disruption Yahoo was once worth $125 billion, and it carried a market cap of over $60 billion for almost a decade as it slowly lost ground to Google, social media, and other newer competitors. It was acquired by a private equity firm for $4.5 billion in 2017. ### Macroeconomic changes What happens when a global pandemic affects supply chains? Or when interest rates reach generational highs? For niche banks like Silicon Valley Bank, rising interest rates exposed a fatal flaw. For a product importer like Aterian, supply chain disruptions led to a 92% decline in its stock price. ### Government oversight and regulatory shifts What will regulation mean for Coinbase and other cryptocurrency companies? What will an antitrust fight mean for Google? Even the biggest blue chips can be affected by changes to how they’re permitted to run their business. ### Business models fall out of vogue Affirm lost over 80% of its value between 2021 and 2023 as its buy-now-pay-later business model lost some of its appeal within the investor base. ### Cultural shifts As shopping malls have become less popular, Nordstrom and other mall anchor tenants have fallen on harder times, too. Most consumer analysis did not accurately predict the degree to which consumers would prefer online shopping – and many retailers did not adequately prepare for it. The lesson? Bad things can happen to good businesses. ## How do investors get into concentrated positions? More often than not, concentration risk is the result of one asset outperforming the rest of your portfolio. We meet a lot of investors who hold concentrated positions, and most of their experiences are similar to one of these three examples: 1. **The stock-earning employee** Joe has been working as a Software Engineer at Apple for 12 years. The stock grants he’s received have ballooned in value to make up a huge portion of his net worth. 2. **The part-time angel investor** Mila is a VP of Operations who moonlights as an early-stage startup investor – mostly in companies her friends founded. 3. **The timely stock picker** Jeevan has a passion for stock market investing and technology breakthroughs. In 2020, he took delivery of his Tesla Model 3, he also invested $50K in TSLA, which has grown 800% since then. 4. **Long-time shareholder** From 2005 to 2012, Beth was a store manager for Costco, and she was able to buy more than $40K of stock through the employee stock purchase plan. ## How diversification can reduce risk If you find yourself in a concentrated position, it’s probably the result of hard work, insight, and at least a little luck. So, why diversify? When holding a highly appreciated stock, a criticism of diversification can be that it lowers your potential for high returns. Over long periods of time, only a handful of stocks turn into juggernauts that go up exponentially. **When you own a diversified portfolio, there’s a greater chance that some of those high-performing stocks are part of it.** ## Barriers to diversification Even if diversification is aligned with your objectives, a number of practical and emotional considerations might keep you from actually doing it. From potential tax consequences to fear of missing out on hypergrowth, there can be a lot of potential hangups. Here are the biggest obstacles: ### Tax tradeoffs Concerns about taxes are the most common reason for inaction. If you’re in a high tax bracket, your long-term capital gains taxes can range from 23.8% to 38% depending on where you live. ### Loyalty to your company It is hard to diversify when you’ve spent years working at a company and cheering for its success. ### Anchoring bias When you see a specific price associated with any type of good, your mind tends to latch onto that number when making decisions. ### Fear of Missing Out (FOMO) Building your concentrated position has probably been rewarding in lots of ways. Who wouldn’t want the ride to continue indefinitely? ## Tools for managing concentration risk When you’re ready to diversify away from a concentrated position, you’ll have three objectives you need to balance: 1. Reducing your concentrated holding below 10% of your portfolio 2. Replacing your concentrated stock with assets that spread your exposure more widely 3. Limiting the tax burden you’ll take on ### Common tax-advantaged alternatives - **Exchange funds**: Pool your concentrated stock with stocks from other investors to create a diversified fund. - **Qualified small business stock exemption (QSBS)**: May cover 100% of your capital gains tax liabilities. - **Charitable giving vehicles**: Offset tax liabilities while allowing for diversification. - **Estate planning**: Steps up the cost basis of concentrated stock passed to heirs. - **SMAs with tax-loss harvesting**: Buy all the stocks in an index fund to capture capital losses. ## Next steps for your portfolio If one stock makes up a big part of your portfolio, understanding the risks and investigating your options is the right thing to be doing. Our company, Cache, offers modern exchange funds that may be able to help you diversify your portfolio, defer your taxes, and meet your investment goals.