Do You Own Too Much of Any One Stock?
In the wake of the collapse of Enron Corp., investors across the country are reassessing their retirement plans to determine whether they own too much of their companies' stock. But as they reallocate portfolios and shift money into different asset classes, a question remains: How much of a single stock can investors own in an otherwise well diversified portfolio before their overall return is significantly impacted?
To answer that question, the Schwab Center for Investment Research reviewed data from 1926 to 1998. Researchers examined 25,000 simulations of a portfolio consisting of various percentage allocations of a single, randomly selected stock in an otherwise diversified portfolio. Their conclusion: The risk associated with a concentrated stock holding begins to dramatically impact a portfolio when it makes up between 20 and 30 percent of an investor's overall investments.
"Our research shows that once you reach the 20 to 30 percent threshold, a concentrated stock holding dramatically increases the overall risk to your portfolio," said Bryan Olson, vice president of the Schwab Center for Investment Research. "Concentrated stock positions can turn retirement investing into an unpredictable roller coaster ride. A more sound approach to successful long-term investing is to build a foundation of holdings that are well-diversified both within and across asset classes."
Among the risks of a concentrated equity position:
- Volatility: The returns on a portfolio with a concentrated equity position will typically be more volatile than the returns of a diversified portfolio.
- Portfolio under-performance: A portfolio's risk of substantially under-performing the stock market increases significantly with a concentrated position.
- Missed goals: Underlying goals such as sending a child to college, starting a business, or retiring early may not be achieved.
While these risks apply to any concentrated position, employees who over-invest in company stock significantly increase their exposure to a potentially compounded risk. "When an employee's basic income, retirement plan investment, and, for some, incentive-based compensation such as stock options, are all tied to the fortunes of a single company, there could be an escalating risk of job and investment loss. That's something investors should avoid," said Olson. "Asset allocation is a smart, time-tested strategy for helping investors meet investment goals and avoid the risks associated with concentration."
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