No matter how much you may love the company you retire from, do not keep a concentrated position of their stock, or any stock, inside or outside of your IRA. The risk in any one stock is just too great. Remember the companies that were investment darlings: Enron, WorldCom, Global Crossing, Conseco, Lucent, Qwest, Cisco, Sun Microsystems, Oracle. Investors who maintained concentrated positions in these stocks also concentrated their losses. The beauty of a concentrated position in an IRA is that you can sell it and diversity with no tax implications. Do it, and do it today.
Here’s the research conclusion of a major investment research firm based on their 20-year study of concentrated positions:(1)
- A single stock presents investors with an inferior risk/reward profile:
- The higher volatility of an individual stock diminishes its expected long-term growth. Over the last 20 years, stocks with average volatility have lagged S& P level returns by nearly three percentage points per year. For the most volatile quartile of stocks, the drag on performance has been close to seven points.
- There is a pronounced skew to single-stock returns. While the additional return potential for holding the right stock is substantial, significant underperformance has been four times as likely.
- Reducing concentrated positions can help most investors achieve their long-term goals. A minimum divestment amount, tailored to the investor’s circumstances, should be considered to ensure meeting spending needs. An optimal sale amount can be quantified, based on the investor’s time horizon and risk tolerance, the tax cost of selling, the volatility of the single stock, and the level of portfolio concentration.
If this warning is not sufficient for you and you are convinced that you have a concentrated position in the greatest stock in the world, then at least hedge your best. There are a few options other than selling:
Purchase a Put Option—A hedging strategy in which the investor wants to protect the downside price risk below the put price. The investor pays a premium upfront for downside protection below the strike price, and is able to fully participate in the appreciation of the stock, minus the premium paid.
Zero-Premium Collar—A hedging strategy in which the investor simultaneously writes a covered call option and purchases a put option with equal premiums for a net zero out of pocket cost. The investor eliminates downside risk below the put strike price, participates in the appreciation up to the call strike price, and has full exposure to the stock volatility between the call and put strike prices.
The concentration of the position and appropriate action should be viewed in light of your entire net worth as part of your total financial planning.
(1) Bernstein Wealth Management Research, April 2004, “The Enviable Dilemma, Concentrated Stock” 2004 https://www.bernstein.com/CmsObjectPC/pdfs/pub_ssb_0404_mod.pdf. Bernstein (previously Sanford Bernstein) is a wealth management division of Alliance Capital LP managing over $50 billion of assets.