By Matthew Gaude & Shawn McGuire
We’ve all heard the warning: Don’t put all your eggs in one basket. In the world of finance, we speak to the importance of diversification as a way to avoid having all your funds invested in one company or one product. After all, if your funds are all in one place and you enter a bear market, what then? We work with a lot of clients who work for a publicly traded company and have the option to purchase shares through an employee stock purchase plan. A lot of employees contribute to their plan thinking the shares of the company they work for will increase over time. Besides, most benefit by being able to purchase shares, usually at a 15% discount to the closing price, on a certain date.
Why would it be a bad idea to concentrate your assets in your company stock and believe you know more about the company than the market or management of the company? Because investing the majority of your funds in individual securities carries increased risk. Let’s break this down further.
The Risks of Investing in Any Single Stock
Individual stocks are much riskier investments than a well-diversified portfolio. Why is that?
Here are a few kinds of risk you are exposed to when you hold any single stock, or if your portfolio is heavily invested around one single stock:
- Management risk: A company may have a stellar history of management, but there are no guarantees that won’t change in the future. A change in management, like a CEO stepping down, can cause a significant shift in how the company performs, the future prospects for the company and, in turn, the current price of the stock.
- Industry-specific risk: When you are invested in a stock, you are also invested in that industry. If this industry takes a hit from world events, supply chain issues, changing consumer demand, or rising costs, your individual stock can also go down in price.
- Legal risk: If the company of the stock you hold gets into legal problems, it can lead to investor concerns, and the stock price could drop.
- Technological risk: Technology is continually changing and advancing. It is nearly impossible to predict these changes, and when major advancements in technology occur, it could render an entire company or industry obsolete.
Lastly, the more you concentrate your investment in a single company, you also run the risk of becoming emotionally invested in the company. When the company you’re invested in doesn’t do well, this can lead to suboptimal investment decisions (e.g., selling at low prices). Most importantly, do not fall in love with the stock of the company you work for. In the end, supply and demand of the stock market determines the price of individual companies. I have seen too many times where employees had the opportunity to sell their company stock and realize many thousands of dollars of profit (and in some cases tens of thousands of dollars), but thinking they know everything, they continue to hold on to the stock. Then the stock goes lower and they have given up most, if not all, of their profit.
When you have most of your money concentrated in any single stock, if something goes wrong, you stand to lose a significant portion of your investment. But this can be avoided. It is always a good idea to sell some shares at a profit, realize some of your gains, and diversify into other areas of the market. If the stock continues to go higher, you still have shares that you own to take advantage of higher prices with the ability to sell more.
The Importance of Diversification
Most of the time, the purchase of company stock will amount to a smaller overall allocation to an individual’s portfolio. However, if you work for a small company or start-up that pays some of your salary or bonus with company stock with a lower cost basis, this can be even more important to manage according to the company guidelines. Diversifying your portfolio gives you exposure to companies and industries that appeal to you without the danger of putting all your eggs in one basket.
There are many factors outside your control, such as future company performance, industry changes, and world events. You don’t want to be left holding shares in a company with unforeseen events that could wipe out the value of your shares—whether it be through bankruptcy, changes in technology or management, or a bear market.
The Bottom Line
With any investment, you need to consider your risk tolerance and goals before you make a purchase. All investments carry some amount of risk, but diversifying your portfolio can help you minimize the risks of owning concentrated positions in any specific asset, company, or industry.
So when it comes to how much stock from one company is safe to own, the answer depends on your needs, goals, and risk tolerance.
We Can Help
Live Oak Wealth Management is not your ordinary advisory firm. We offer independent, unbiased financial advice to our clients. Our team was built to stay true to our ideals of always putting our clients’ best interests first and offering objective financial advice.
To get started, call our office at 770-552-5968 or email [email protected]. Or, if you prefer, you can simply click here to schedule an appointment online.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc. (APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. Seek tax advice from a tax professional. Neither APFS nor its Representatives provide tax, legal or accounting advice.