Single-Stock Concentrations

It can be hard to fault someone for choosing not to diversify their company stock when companies like Google, Facebook and Amazon have performed as well as they have in the last decade.  If the proceeds from that potential diversification is earmarked for something like bonds, the reaction could well be, "how will that ever generate a higher return than my RSUs?"

And herein lies the problem.  There is a subtle but significant distinction between maximizing expected return, and trying to maximize the odds of reaching or maintaining a certain value for your portfolio over time.  The former is fueled by risk, and has no optimizing upper bound.  The latter will always have an inflection point beyond which taking more risk to generate more expected return will actually *lower* the probability of meeting a certain minimum value (say $1 or more by age 100).

And individual stocks are quite a bit more volatile than even broader equity benchmarks:

Virtually every financial advisor, robo-advisor and portfolio optimizer out there are either ignoring all of your stock that makes up the dark grey curve ... or they are making a simplifying assumption that your single stock doesn't have that shape at all, and instead behaves just like  the orange curve.  Both result in dramatic underestimates of risk -- which then lead to overly aggressive investment choices outside of your company stock.

Why don't firms model single-stock positions more accurately?  Because the amount of stock concentration differs greatly across clients - and changes frequently due to vesting and performance of the stock.  So it is a lot of work to build an optimized allocation around each client's concentrated stock position.  The industry is built for scale - not customization.  So treating Google the same way as the S&P 500 (or worse, ignoring the fact you own it at all) becomes the norm.

Despite the systemic under-valuing of risk in portfolios, this rarely means those individuals should sell all of their single stock positions.  It simply means they need to objectively evaluate the proportion that serves them best in reaching their goals.  And to the extent that proportion is lower than their current holdings, determine the most efficient way to manage that risk.  Sometimes that means selling shares.  Other times it means using an option strategy to narrow the possible return outcomes.  Still other times it means using an exchange fund to "swap" your company stock for diversified market exposure (without triggering capital gains).  There are a number of strategies available -- but the first critical step is modeling the shares you hold accurately, and then determining the amount of stock concentration that serves you well in reaching your goals.

If your current investment strategy is not accurately analyzing your stock concentration, contact us to schedule an appointment, and get a clearer picture of your optimal portfolio.