Key points
  • By leaving equity awards in company stock unmanaged, an employee may build an unintended concentrated position.
  • Holding a concentrated position in company stock could lead to underperforming the market and incurring excess volatility.
  • Advisors should consider strategies to help clients reduce single-stock risk and target more consistent alpha.
 
Pride and company loyalty are common reasons an employee might hold onto company stock for a long period of time, and the longer they stay invested, the more unrealized gains can potentially grow. However, this may lead to unintended concentrated positions — potentially putting their well-earned wealth at risk.
 
The ties that bind: Risks of a concentrated position
 
While investors may naturally resist letting go of a stock that has delivered strong returns, it’s important to keep in mind that employees are already tied to the success of their company through cash compensation. So, holding a concentrated stock position doubles down on that company’s fortunes (or failures) — a high correlation that runs counter to the proven benefits of diversification. If we look closely at the largest U.S. companies, we see that few will reap the benefits of overconcentration. Consider this staggering statistic, based on the last five years:

 

Employees of the 10 largest companies (by market capitalization) have enjoyed an average cumulative return of 535%, while everyone else has seen an average cumulative return of just 63%, dramatically underperforming the markets. 
 
 
Strategies to reduce company stock concentration
 
Regardless of how well a stock has performed in recent years, leaving a concentrated position in company stock unmanaged comes with potential risk. Fortunately, there are ways an advisor may help reduce this risk for clients:
  • Recommend selling some shares immediately after vesting and delivery, with little to no additional tax obligation. 
  • When it comes to options, and in particular non-qualified stock options (NSOs), a net exercise and sale allows employees to receive the shares left over after paying off both the cost to acquire those options and the related income tax.
Exercising options, selling company stock or diversifying out of a concentration position may come with a tax bite, but for many investors, the tax owed to unlock those dollars beats the risk that comes with doing nothing.
 
To help your clients build tax- and risk-aware strategies, explore our equity compensation resources. 
 
 
 
The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that any forecasts are accurate. Investing involves risk including the risk of loss of principal. The S&P 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks. Indices are not managed and do not incur fees or expenses. It is not possible to invest directly in an index.
 
Standard Deviation is a statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution.
Columbia Threadneedle Investments and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
 
Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies. Columbia Management Investment Distributors, Inc., 290 Congress Street, Boston MA 02210
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