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The Five Myths That Put Portfolios at Risk: Myth #2 Sell Stock to Reduce Concentrated Risk

The Five Myths That Put Portfolios at Risk: Myth #2 Sell Stock to Reduce Concentrated Risk

Our series on the five myths that put portfolios at risk examines the reality that many individual investors and advisors do not broadly understand the concepts and disciplines of portfolio risk. Current beliefs are often from outdated ideas that are commonly accepted. One such belief is that selling stock reduces the concentrated risk in portfolios.

However, in today’s modern market system, risk in portfolios needs to be assessed and managed differently to yield different results and doesn’t always require selling off the stock. At StratiFi, we believe that a much greater focus on defining and managing risk benefits both advisors and their clients.

The world’s wealthiest people have the most concentrated stock positions. Just think of Warren Buffet, Bill Gates, Jeff Bezos, and so many other corporate leaders. It’s a backroom joke on Wall Street that the way to get rich is through concentrated stock positions. Yet, most people are advised to diversify their concentrated positions by selling stock and buying other assets.

Those recommendations are made even though there may be good reasons to maintain the position, ranging from a client’s emotional attachment, hefty capital gains, or even an elemental fact such as the company’s business is simply booming. It is possible that the concentrated stock risk is contributing to upside performance while reducing the downside risk of the portfolio.

This fear of concentrated stock positions reflects a fear of risk. Yet, the decision to mutualize the position’s risk across a portfolio often introduces different risks that are not as broadly understood, and that is often difficult for most advisors and investors to monitor. 

To be sure, the investment community struggles to manage concentrated stock positions. Some investors advise never allowing one stock position to exceed say 10% to 20% of a portfolio’s total value. Others like to continually rebalance the risk of concentrated positions by creating a program that entails regularly selling the stock, say every three months, or at various price points, and then using the sales proceeds to fund a more diverse investment portfolio. Still, others prefer to directly address the position’s risk by using conservative, options strategies to define and manage the risk of large positions.

The structure of the exact solution varies according to the stock, and the client’s beliefs, but the end goal remains constant: protecting positions from stock-specific risks (earnings, economic cycles, and so forth) and systematic risks that can roil the entire market.

To be sure, all solutions introduce a series of plusses, and minuses, into a portfolio requiring investors to decide on the best pathway for themselves. 

Our PRISM™ risk analysis software uses a blend of risk tolerance questionnaires, historical market events, and current market signals to provide advisors with all the data they need to know their customers and plan accordingly. Contact us to find out how StratiFi can help your practice and clients monitor risk across all investment holdings regardless of market conditions.

Akhil Lodha Author
Co-founder & CEO StratiFi Technologies

Building the industry standard for understanding portfolio risk through cutting- edge technology at Stratifi.

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Additional Advisor Resources

Bob Veres features StratiFi in ‘Inside Information’ February 2022 Edition

Bob asks, “Is it really possible that a portfolio risk assessment tool for wealth managers could be as sophisticated as the algorithms that institutional teams are using?”

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