Concentrated positions and what to do about them

Many people arrive at retirement with an outsized holding in one company — usually a former employer. It is the most common substantial risk in an otherwise sensible portfolio.

Why it happens

Stock compensation accumulates over a career and is rarely sold.

Employer plans historically offered company stock as an option and it was frequently chosen.

The holding grew, which reinforced the decision to keep it.

Familiarity plays a part. People overweight what they know, and working somewhere produces a sense of understanding it that does not translate into an investment edge.

And selling triggers tax, which makes inaction feel free.

The risk

Individual companies fail. Large, well-known, apparently stable companies have failed within the working lifetimes of current retirees, taking employees' savings with them.

The particular danger for an employee is correlation: if the company does badly, your job, your pension and your portfolio are all affected simultaneously.

In retirement the employment risk has gone and the concentration remains, generally at the point where the portfolio can least absorb a large loss.

The relevant question is not whether the company is good. It is whether you would buy this position today, at this size, with money you needed for the next thirty years.

Almost nobody answers yes, which is informative.

The tax obstacle

Which is real and is generally overstated as a reason not to act.

The tax on selling is a cost. The risk of holding is a risk. Comparing them requires acknowledging that the tax is certain and modest while the risk is uncertain and potentially total.

Paying capital gains tax at a preferential rate to eliminate a genuine threat to a retirement plan is generally a good trade.

How to unwind it

Sell in stages across tax years, filling low brackets each year rather than realising everything at once.

For someone in the gap years before Social Security and required distributions, this may allow substantial amounts at the zero per cent capital gains rate.

Pair with loss harvesting. Realised losses elsewhere in the portfolio offset the gains.

Donate shares to charity. For those giving anyway, donating appreciated shares captures both the deduction and the avoided gain, and reduces the position.

Use a donor-advised fund to concentrate several years of giving into one year while reducing the position immediately.

Stop reinvesting dividends into the position, which is a simple step that many people have never taken.

Direct all new investment elsewhere, which dilutes the concentration over time without any sale.

The special case of employer stock in a plan

Worth flagging because it involves a provision people are unaware of.

Employer securities held in a workplace retirement plan may qualify for special treatment on distribution, where the appreciation is taxed at capital gains rates rather than as ordinary income.

This can be valuable where the appreciation is large relative to the original cost.

The treatment is lost if the shares are rolled into an IRA in the normal way, which happens routinely and irreversibly.

Anyone with substantial appreciated employer stock in a plan should get advice before rolling it over.

The hedging options

Various strategies exist for reducing concentration risk without selling — options collars, exchange funds and similar arrangements.

These involve cost, complexity, counterparty considerations and sometimes long lock-up periods.

They are worth considering for very large positions with very low basis, and for most people the straightforward approach of selling in stages is better.

The rule worth setting

Decide a maximum percentage for any single holding — commonly suggested figures fall around five to ten per cent of the portfolio — and reduce to it on a defined schedule.

A written plan with dates removes the need to decide each time, which is what prevents the position sitting untouched for another decade.

The question to ask annually

A single check that keeps this from drifting.

What percentage of the total portfolio is in the largest single holding?

If the answer has risen since last year without any purchase, the position has grown through appreciation and the risk has increased accordingly.

Reviewing that one figure each year is enough to prevent the situation redeveloping after it has been addressed.

General information only, not financial or tax advice. Consult a qualified adviser and tax professional before acting on a concentrated position.