Earlier this month, stock of Facebook’s parent company Meta dropped a whopping 26%, its biggest one-day decline ever. Mark Zuckerberg, Meta’s chief executive, saw his personal “paper wealth” decline by a staggering $31 billion, more than the entire market capitalization of companies like Twitter ($30 billion) and Delta Airlines ($26 billion).
Even after this precipitous drop in wealth, he’s still the tenth richest person in the world and it’s unlikely he’s had to make any concessions to his lifestyle. Still, he provides a valuable lesson for us all.
At Uplevel Wealth, we’ve encountered our fair share of clients whose wealth is heavily concentrated in a single company’s stock. If you find yourself in the same position, here are three things you should consider.
1. What’s the Risk?
Investing in a one company’s stock is tremendously risky, as you are concentrating your wealth in the future success of a single company or industry. It can be challenging to see this risk, especially when a company’s stock has performed well recently.
The stock market’s past is littered with former “heros” turned “zeros” – Enron and WorldCom being two of the most famous. While these calamitous crashes garner lots of attention, a more common risk of a concentrated holding is poor performance for a prolonged period of time.
Henrik Bessembinder, a professor at Arizona State University, looked at stock market performance going back to 1926. His research found that only 86 stocks, or 4% of companies were responsible for half the stock market’s wealth creation over 90 years.
The other 96%? Their performance was no better than 1-month Treasury Bills, a government-backed investment whose return is only slightly higher than cash.
As seen in the recent Meta example, individual stocks can also be incredibly volatile, losing significant value over a single earnings report, change in government regulation, or company scandal.
This volatility is especially dangerous for investors who rely on their portfolios for income, expenses like college tuition or a home purchase, or are making future life decisions based on their current net worth.
High volatility greatly increases the risk that stock will need to be sold at some point in the future when its price is depressed, and that the value is not there when it’s needed most.
2. How Much is Too Much?
Common rules of thumb suggest limiting a single stock position to no more than 10 or 20% of your investable assets, but the “right” amount is very specific to your unique circumstances.
Like many clients we encounter, a concentrated stock position has often been amassed while working as an employee for the company in question. Stock options, RSU grants, and discounted employee stock purchase plans are common compensation vehicles and can quickly grow to a sizable portion of your net worth.
Employees also have to be mindful of their own “human capital” investment and the degree to which it, too, is tied to your current employer. This may further reduce the stock exposure you should prudently have.
Rather than relying on one-size-fits-all percentages, we instead evaluate the amount of a single stock position, if any, that makes sense for our clients’ unique circumstances. If the future performance of the stock holding in question is sizable enough to sway the success or failure of a client’s future plans and goals, we often advise a significant reduction.
For someone like Mark Zuckerberg, his astronomical wealth affords him the ability to assume greater stock risk without threatening financial ruin – a position most of us aren’t lucky enough to find ourselves in.
3. What’s the Best Way to Start?
Reducing a concentrated stock position can present its challenges, both on a financial and emotional level.
One of the main hesitations of selling stock, presuming it has appreciated considerably, is the potential tax bill for doing so. Though long term capital gains rates are at historic lows, with the top Federal rate at 23.8% and state rates varying, many investors see taxes as the primary obstacle to diversification.
In reality, however, reducing the inherent risks of holding a concentrated position should far outweigh the tax implications of selling. Afterall, isn’t it better to pay taxes because of investment gains rather than no taxes because of losses?
It’s also common for investors to have emotional ties to their stock holding. Perhaps you have been an employee of the company for many years and have great confidence in its future direction. Or, you were gifted the stock by a beloved family member and feel a sense of duty to keep it.
While both are understandable from an emotional perspective, mixing emotions and investing rarely turns out well. Recognizing this, or working with a competent advisor who can help you work through your hesitation, provides the best probability of financial success.
From a mechanics perspective, the fastest way to reduce the risk and volatility associated with a large stock holding is to sell it all at once. As discussed above, this can often be impractical.
At Uplevel, we work with our clients to create a plan for diversification. Whether that means spreading gains over several tax years, picking monthly or quarterly dates to sell a specified amount, or setting price targets at which trades will execute, creating a disciplined plan is key.
Protect Your Wealth
While concentrated stock holdings can be a great way to build wealth, diversification is the best way to maintain it.
Do you need help creating a plan for your concentrated stock position? Reach out to us at Upevel. We’re here to help.