Concentrated stock positions can put your retirement at risk. Learn what a concentrated position is and six strategies to manage the risk.
A concentrated position occurs when a single stock, or a small group of stocks, makes up a significant portion of an investor’s net worth. There’s no universal threshold for what qualifies, but Morgan Stanley defines it as five or fewer companies making up 30% or more of a portfolio. In our own practice, we treat any single company representing more than 5% of a client’s liquid net worth as a concentrated position worth addressing.
Why a Concentrated Position Is Risky
Individual stocks are far more volatile than broad market indexes, which makes concentrated positions inherently riskier than a diversified portfolio.
Consider the numbers:
- The worst calendar year in S&P 500 history was a 8% decline in 1931, during the Great Depression.
- Countless individual stocks have lost more than that in a matter of months, some losing 100% of their value after going out of business.
- Since 2014 The Russell 1000 Index has an average volatility of 15%, while the average volatility of individual companies within that same index is 37%.
For investors nearing or in retirement, having a large share of liquid net worth tied to one volatile stock can jeopardize an otherwise sound retirement plan.
Six Ways to Mitigate a Concentrated Position
1. Sell and Diversify
The most straightforward approach is to sell the position (or a large portion of it) and reinvest the proceeds into a diversified asset allocation. The main drawback is the potential tax impact if the position carries a large, unrealized capital gain, an issue several of the strategies below are designed to help offset or defer.
2. 130/30 Strategy
As we covered in a previous article, a 130/30 strategy involves maintaining 130% long exposure to stocks expected to outperform, while holding a short position equal to 30% of the account in stocks expected to underperform. An experienced manager can use this approach to generate tax losses while maintaining broad market exposure and generate losses that can then offset capital gains created by selling down the concentrated position.
3. Direct Indexing
Direct indexing uses a Separately Managed Account (SMA) to buy and hold each individual stock in a given index on behalf of an investor. Unlike an ETF or mutual fund tracking the same index, an SMA doesn’t pool assets with other investors, giving the investor direct ownership of each underlying company. As with the 130/30 strategy, a skilled manager can generate tax losses within the SMA to help offset gains from selling the concentrated position. (See our full guide to direct indexing for more detail.)
4. Exchange Funds
An exchange fund is a private investment vehicle that lets an investor swap a concentrated position for a diversified portfolio. Because the transfer isn’t technically a sale, capital gains taxes are deferred rather than triggered. This strategy typically requires a holding period of at least seven years, sometimes longer.
The main drawbacks: it usually requires a substantial amount of appreciated stock to participate, and the funds are illiquid for years.
5. Options-Based Strategies
Options can help hedge a concentrated position, most commonly through a combination of two strategies:
- Protective puts – buying an out-of-the-money put on the stock
- Covered calls – selling an out-of-the-money call on the same stock
Together, these create a “collar” around the position, limiting both downside and upside. The purchased puts protect against losses if the stock falls, while the premium from the sold calls helps offset the cost of the puts. In some cases, depending on the volatility of the underlying security, the proceeds of the call may completely cover the cost of the put.
6. Charitable Giving
For charitably inclined investors, donating appreciated stock, rather than cash, is a more tax-efficient way to support causes you care about. A Donor Advised Fund (DAF) is one of the most common vehicles for this. It functions as a private charitable investment account: contributions are tax-deductible in the year they’re made, assets grow tax-free within the fund, and the donor recommends grants to charities over time.
Investors can also work with an estate planning attorney to create their own charitable gifting trust. Some options are a Charitable Remainder Unit Trust (CRUT) or a Charitable Remainder Annuity Trust (CRAT). Both options offer sizable upfront charitable deductions for the gifting appreciated securities, while allowing you to keep a retained income from the trust of between 5-50%.
Conclusion
Concentrated stock positions can quietly undermine even a well-built retirement plan, since individual stocks carry far more volatility than the broad market. The good news is there’s no one-size-fits-all fix, whether it’s outright selling, tax-efficient strategies like direct indexing or exchange funds, options-based hedging, or charitable giving, investors have real options for reducing risk while managing the tax consequences. The right approach depends on your goals, time horizon, and tax situation, so it’s worth working with a financial advisor to find the strategy (or combination of strategies) that fits your circumstances best.
About the Author
Aaron Belletsky, CFP® is a Certified Financial Planner® and an associate financial advisor with Landmark Wealth Management, LLC, a fee-only SEC registered investment advisory firm. He works with individuals and families develop comprehensive financial strategies to achieve their long-term goals.