Many new Schneider Wealth Management clients have a large part of their net worth in one company stock: typically the stock of the company where they work: Google, Apple, Facebook, or other Silicon Valley Companies.
An investing guideline you may often hear is that you should not keep "All your eggs in one basket." In other words you should diversify your holdings or run the risk of losing everything since you could have your net worth change dramatically in a short period of time for the worse. The prudent rule of thumb is to not have more than 10% in any one investment.
This is generally good advice; however, sometimes, some investors can make choices that keep a high concentration in one investment without risking accomplishing their goals.
After all great wealth is often obtained by concentrating ones assets in one holding.
So when might it make sense to abandon the rule of thumb of "Not keeping all your eggs in one basket” or keeping more than 10% in one investment? Or when does it make sense to explore the idea of not diversifying a concentrated position?
Here are a few examples of concentrated stock position. For one investor it does make sense to diversify, in the other two, the investors come to a different conclusion.
1. Mid Career Investor
95% of Assets in One Investment
$4,000,000 in Facebook stock - some of the holding are unvested RSU’s
42 Year old Investor
Home with $1,100,000 mortgage
Works at Facebook
Annual expenses $135,000 per year
$210,000 in 401(k)
No debt other than mortgage
Would like to have Financial Independence
Aggressive Risk Tolerance
While this investor has an aggressive risk tolerance, having the majority of her investable assets in one company, the company from which she earns her income, is a very high risk situation. This investor should consider diversifying at least some of the Facebook position into a diversified portfolio.
2. Investor with a bond portfolio that generates an income that supports lifestyle
$6,000,000 in Google stock, 55% of investable assets
$4,000,000 invested in tax-free muni investment grade bonds generating $120,000 worth of income each year
Age 52 Investor
Home without mortgage
Works at Google
Annual expenses of $95,000 per year
$1,000,000 diversified equity portfolio
No debt
Enjoys work with no plans to retire or stop working soon
Moderate Risk Tolerance
Although this investor has 55% invested in one stock, which is considered a high risk situation, this investor also has the balance of funds invested in such a way that makes diversifying the Google holding not as urgent as Investor #1. The investment grade bonds generate more income than the investor needs each year, and this investor plans to continue working for the foreseeable future. This investor also has some additional diverse funds invested in stock that should over time generate growth that could potentially enable purchasing more bonds in the future in order to have the bond income keep up with potential inflation in his expense needs.
3. Retired Investor
$10,000,000 in Hewlett Packard, 100% of investable assets. Current dividends paying around $345,000/year
Pension paying $38,000/year
Social Security paying $26,000/year
Age 82 Investor
Home without mortgage
Retired
Annual expenses of $68,000/year
No debt
Moderate Risk Tolerance
While retired investors are often reliant upon their investments for income and do not usually reliably have the luxury of time to withstand a market correction or recession, some may choose to in fact not sell a concentrated position in order to avoid capital gain taxes on their investments and have heirs benefit from a step-up in cost basis upon inheriting assets. This investor has three sources of income: dividends, pension, and social security. The latter two are very reliable, leaving the dividends as the more uncertain source. The amount of dividends needed to make up the difference between spending and those two income sources is very small. This investor only needs a small amount in dividend income to meet spending needs, and currently has $345,000 in dividend income, so the risk of that declining to zero is pretty low. Not zero risk, but enough of a low risk that this investor is willing to keep such a high concentration in order to pass on the asset to heirs who will receive a step-up in cost basis upon death of this investor.
Every person has their own unique situation, and what is best for them is based on his/her own goals, resources and risk tolerance. So while diversifying is often a prudent step to take, it is not always the right choice for everyone. Working with a financial planner and tax advisor can help you decide what is the right choice for your situation.
Meredith Schneider, CFP® is a Palo Alto & Redwood Shores, CA fee-only financial planner. Schneider Wealth Management provides financial planning and investment management to help technology executive, engineer, and attorney clients plan for financial independence and spend more time doing what they love to do. Schneider Wealth Management serves clients as a fiduciary and never earns a commission from an investment or insurance recommendation. While the majority of Schneider Wealth Management’s clients live and work on the San Francisco Peninsula, through technology tools such as online conferences, the firm is able to serve clients worldwide.