Managing Concentrated Investment Position(s)



With the runup of stock market prices over the past several years, investors might find one or more of their investment holdings have appreciated considerably in value, now representing a disproportionate percentage by market value. With this in mind, it is important for investors to pay attention to these concentrated investment position(s), an important investment concept that often is over-looked for proper portfolio management.

A concentrated position can be defined by different measurements, but commonly can be defined when an investment holding exceeds in market value 10% of the total portfolio value. For investor’s, managing these concentrated positions can be difficult for a variety of reasons, such as having a low tax basis. When such positions are owned in taxable accounts, reducing/selling such positions can result in excessive taxable consequences. Other reasons for allowing a position to become excessive can be due to emotional attachment.

For these reasons among others, many investors often make poor investment decisions associated with their concentrated holdings. Investors with concentrated positions need to adopt a planned process of reducing these position(s), thereby safeguarding their overall portfolio performance. Alternatively, by remaining concentrated in one or more portfolio positions, investors face both market risk and specific risk, where one or more of their concentrated positions decline substantially in market value outside of the investors’ control.

Investors with concentrated positions may like to consider the following questions as to why it is important to take a hands-on approach to manage concentrated positions:

Is the account currently taxable or tax deferred?

When selling in taxable accounts, investors must weigh the tax consequences of sales, and the required growth rate of the after-tax investable proceeds to reach long-term goals. Consider the following example. Currently taxable investor A sells a stock with an original cost basis of $10,000 for $15,000, realizing a $5000 long-term capital gain. The investor pays a federal tax rate of 15% on capital gains, and 5% state tax, resulting in an after-tax investable amount of $14,000.  What growth rate is now needed for the $14,000 to grow to an expected need of $20,000 over 7 years? 5.11%. In comparison, if this taxable gain is not realized, what growth rate is needed for the original $15,000 to grow $20,000 over 7 years? 4.11% – a full 20% less!   This example illustrates that paying the tax sooner reduces the amount of principal working for the investor.  By deferring a taxable sale, the capital gains tax is deferred, allowing the principal amount to grow.

What, if any, opportunity cost am I missing out on?

By leaving the money invested in the concentrated position, am I missing out on finding an alternative investment(s) that could perform better?  Do I need the money for something else?

Successful investing includes regular monitoring of investment holdings, doing the necessary research to find replacement candidates for reinvesting that provide greater upside, long-term performance.  Holding a concentrated position that underperforms the market year in and year out can be more damaging than gradually reducing the position to a more manageable size, paying the taxes, and reinvesting the sale proceeds within proper guidelines for your portfolio diversification and risk tolerance.

Another important consideration: when do you actually “need” the money?  As a rule, money needed in the short-term, should not be invested in the stock market.  The stock market is a long-term wealth builder.  Therefore, market corrections are less important if the portfolio is designed as such. Additionally, even if you assume you could time the market perfectly on the sell side, your sell decision requires you to reinvest the proceeds at an advantageous time too. Market timing is notoriously difficult.

How much volatility can you emotionally withstand?

Volatility – i.e., variation of return over the short-term – can cause investors to overreact both at market highs and at market lows.  Investments are affected by infinite number of variables: competition, regulation, patent expiration, better mousetraps, etc. Investors face both market risk and company specific risk, and these are impossible to predict consistently.  If your temperament would likely cause you to make a tactical mistake, then a bird in the hand may be worth more than two in the bush.  If on the other hand you have a long-term buy and hold, well diversified portfolio that you can live with, then you should also have more staying power as you gradually reduce any concentrated position(s) in your portfolio.

Will future capital gain tax rates be favorable?

History has shown tax laws are not set in stone and there are no guarantees future capital gain tax rates will be more, or less, favorable.  Changes in Washington, recent political discussions and increased government spending all point to the likelihood of rising capital gain tax rates. Holding concentrated positions does not avoid paying capital gains taxes, it merely delays the payment, unless the goal is to never sell, and rather, pass concentrated holdings to heirs or charity.  However, this too is open to new discussions, with proposed changes in inheritance taxes and limits on charitable deductions.  Given current capital gains tax rates are known, and generally favorable to historic data, there is little reason to tolerate the risk of concentrated positions in hopes of delaying an inevitable taxable event.

What is your degree of loss aversion?

According to Wikipedia: “Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. The principle is prominent in the domain of economics. Loss aversion implies that one who loses $100 will lose more satisfaction than the same person will gain satisfaction from a $100 windfall.”  How about you?  Investors should keep in mind when considering losses in the short run, that while the stock market certainly rises over the long run – periodic setbacks are normal.   Understanding your degree of loss aversion will help you to follow through with necessary steps to reduce concentrated positions.

So, what can investors do? Adopt a planned process to reduce concentrated positions! The worst approach for a portfolio with one or more concentrated positions is to do nothing. Investors can either address their position and resolve it through careful planning or let potential outside negative forces resolve the issue, resulting in market losses, higher taxes, or a combination of both.

Provided here is one approach that investors might find helpful:

  • define your measurement of a concentrated position.
  • organize holdings across all investment accounts to identify any concentrated position(s);
  • develop a plan to gradually reduce these concentrated positions over a set time frame, taking into consideration taxable consequences, and opportunity cost;
  • find replacement candidates for reinvesting, hoping to find those new investments that provide greater upside, long-term performance.

In summary, a plan needs to be put in place, and then acted upon, even if it means just a token first step. The first step is always the most difficult, and subsequent adjustments are often easier to implement. Concentrated positions are significant risks and need to be addressed. The benefits of effectively managing these positions clearly outweigh the costs (taxes, opportunity, and emotional) one might incur.

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