T. Rowe Price Personal Investor - Helpful actions you can take if your portfolio is too concentrated in one equity (2024)

Investors seek to select investments that will gain more value over time than the alternatives. However, investors should be aware of the risks that accompany rapid growth of an investment. When a holding of a single company outgains other investments, it can grow to represent a large portion of a household’s overall portfolio. This scenario represents a concentrated stock position, and it can add to the risks in a portfolio—sometimes without the investor fully recognizing it.

“Concentrated positions are a concern because stocks inherently carry market risk,” says Roger Young, CFP^®, a thought leadership director with T.RowePrice. “You could lose a large portion—or even all—of your investment, which would have an outsized effect on your household’s overall portfolio in the case of a concentrated position.” While a more diversified portfolio still carries market risk, it helps reduce the company-specific risks in a portfolio.

Concentrated positions can develop from a specific holding outperforming the broader market, but they can also occur through other circ*mstances. For example, an investor can inherit a concentrated position from a trust or estate, or employees may find themselves with a concentrated position after receiving stock options or shares from their employer. “Employer stock is a common reason that our clients have concentrated positions,” notes Allenbaugh.

It’s critical to monitor your accounts for concentrated positions within a portfolio. Any investor buying and selling individual stocks should check for concentrated positions in their annual review process. It is also important to review your portfolio as a household to account for any overlap in the holdings of both spouses. Major financial events such as a stock grant or inheritance should also trigger a review.

Concentrated positions tend to be less of a factor for mutual fund and exchange-traded fund (ETF) investors as these funds provide diversification through exposure to potentially hundreds of companies represented in their holdings. However, it’s worth keeping an eye on your accounts if you have a significant allocation to any single fund. (See “Concentrated Positions for Mutual Funds or Exchange-Traded Funds (ETFs).”)

A concentrated position means your portfolio is not fully benefiting from diversification. To avoid a concentrated position, invest the assets in your portfolio across different companies, sectors, and geographic regions. Doing so means you will be better insulated against a steep decline in one specific section of the economy or stock market.

Once you’ve identified a concentrated position, it can be resolved by selling a portion of the holding to bring it below the target threshold, whether 5% or 10%. This seemingly straightforward plan can prove more complicated in practice, however.

In a taxable brokerage account, selling stocks that have gained value typically triggers capital gains taxes.Many investors are understandably concerned about adding to their tax bills. Investors may also want to hold on to the appreciated positions, intending to pass them along to the next generation to benefit from the automatic step up in cost basis. But doing so can mean carrying significant portfolio risk that may jeopardize your broader financial plan.

Emotions can lead to hesitancy as well. It can be hard to sell a stock that has grown rapidly with no signs of stopping or to sell shares in a company or brand that you believe in. Investors may also have a false sense of security about the future of a large, well-established company that is not warranted by the stock’s underlying fundamentals. For their part, retirees who hold a concentrated position in a dividend-generating stock may not want to give up the steady income stream delivered by their investment.

For each source of hesitation in trimming a concentrated position, there is another way to think about the situation:

Concerned about taxes? Consider that a large price decline in one holding could have a far greater negative impact on your portfolio value than the tax liability on the gains of the shares you choose to sell.

You want to support the brand? Remember that a company and its stock are not the same. You can still support a brand without maintaining the same financial exposure to its stock.

Confident in the future growth of that large-cap stock? Unfortunately, the stock market is littered with names that were once titans of their industry and yet rapidly lost their value.

Worried about losing out on dividends? Know that dividends are just one way to generate returns, and it’s important to consider the total return of a portfolio. Also, dividend-paying stocks do not necessarily provide a greater buffer against price declines than non-dividend stocks and can still lose value.

Ultimately, consider how a dramatic decline in the stock price of a concentrated holding would affect your portfolio and thus your financial plan. For example, say you have a $200,000 investment in a single stock in your portfolio. You could hold that position or choose to reduce your risks by selling a portion of it and reinvesting the proceeds in a diversified fund.

In this hypothetical example, stocks experience a downturn. The individual stock declines significantly, while the broader market only experiences a correction-level decline. In this case, diversification would help mitigate risks in the portfolio and could leave an investor with almost $10,000 more in the portfolio—and just over $13,000 if you account for the taxes each portfolio still owes. (See “Diversification Can Reduce Impact of a Sharp Stock Decline.”)

Once you’ve recognized that you have a concentrated position in your portfolio and are willing to do something about it, there are a few key steps to consider. Some steps are accessible to all investors, while others require a level of technical expertise that makes them better suited for more complex situations. (See “A More Complex Approach.”) Consider the following potential solutions:

1. Stop reinvesting dividends. While not the biggest step you can take, choosing not to reinvest helps slow the growth of the concentrated position.

2. Quantify your potential capital gains liability, and develop a plan. Consult a financial professional to assess your tax liability from the concentrated position and develop a plan to address the sales of those shares in a tax-efficient way. This approach might include a capital gains “budget” that will spread out your liability over multiple years as you trim the concentrated position over time. Also, a concentrated holding from an inheritance can likely be addressed quickly, as the step up in cost basis that comes with an inheritance may allow you to sell the concentrated position without significant capital gains taxes.

“Today’s capital gains rates are lower than many people realize,” says Allenbaugh. “It may be easier to address the issue than you think.” (See “Federal Capital Gains Tax Rates by Income.”) By planning ahead, investors can potentially limit the gains subject to higher federal and state tax rates or the net investment income tax.

3. Make a plan for the proceeds. If you decide to sell a portion of the concentrated position, plan ahead for the proceeds. Consider reinvesting those assets in a mutual fund or ETF. By their very nature, these types of funds help avoid concentrated positions by providing investors with exposure to the shares of many different companies.

4. Consider a charitable donation.You can donate appreciated stock (generally held for a year or more) directly to a charity without triggering any capital gains for you or the charity. You can then deduct the full value of the donated securities (subject to limits). If you want to spread the donation over time, or the charity you have in mind isn’t well equipped to receive donations of stock, consider contributing to a donor-advised fund. If the position was accumulated over time, work with a financial professional to identify the most advantageous specific tax lots to donate.

5. Gift shares to your heirs. You can keep the shares of the concentrated position within the family by spreading them out across multiple family members. This strategy can help reduce your individual exposure while taking a step toward future estate planning. Keep in mind that the gift tax exclusion is $18,000 per person, per year (in 2024), so larger gifts could mean filing a gift tax return and possibly paying additional taxes. In addition, the recipient of the shares may ultimately face capital gains taxes—unlike a transfer at death, there is no step up in basis for gifted shares. You may also want to consider creating a trust to help facilitate the transfer process.

Whatever approach you take, the most important step is to first recognize the risks of holding a concentrated position in a single company. The next step is to act. “The longer you wait, the larger the concentration might become, and it is hard to predict what tax rates in the future might be or how markets will move,” says Young. Investing in stocks carries risks, but limiting concentration can help mitigate those risks.

Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.

ETFs are bought and sold at market prices, not NAV. Investors generally incur the cost of the spread between the prices at which shares are bought and sold. Buying and selling shares may result in brokerage commissions which will reduce returns.

Past performance is not a reliable indicator of future performance. All investments involve risk, including possible loss of principal. All charts and tables are shown for illustrative purposes only. Diversification cannot assure a profit or protect against loss in a declining market.

Trading options can be speculative. Options are not suitable for all investors; carefully consider your financial position, investment objectives, and risk tolerance before trading. For a more detailed explanation on the nature and risks of options, please refer to the Characteristics and Risks of Standardized Options (PDF).

Important Information

This material has been prepared for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.

The views contained herein are those of the authors as of June 2024 and are subject to change without notice; these views may differ from those of other T.RowePrice associates.

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