Most investors know a diversified portfolio makes great sense. It won’t produce a grand slam homerun, but it always mitigates downside risk and could help you avoid an outright financial catastrophe, helping you sleep better at night.
Nonetheless, a large number of people hold a single stock, sometimes for decades. They might be senior executives who receive stock options, investors who enjoyed an unusually good ride with a particular stock and fell in love with it, or family members who inherit a large position in a single stock and feel compelled to keep it.
Some of these people no doubt keep the stock because they don’t want to sell and chalk up a big tax obligation – in their mind, a “certain loss.”
Other reasons for holding one stock include:
- People are overconfident in the stock’s prospects, especially if it is their employer, and feel they will ultimately regret selling it.
- People assume the future will be like the past, especially if the past has been kind. (If you own a stock like Apple, for example, the most valuable on the planet and one that has set many new highs over time, you might believe you almost can’t go wrong as long as you’re patient.)
- People feel loyal to a stock they inherited from a trusted family member.
- People cannot bring themselves to sell the stock at a price below its former high. So they are waiting for the stock to “come back.”
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In almost all these cases, people are making a mistake. All stocks are vulnerable — period. Last year, Robert W. Baird & Co. constructed a hypothetical diversified portfolio of 60% equities and 40% fixed income and compared it with 309 individual stocks in the S&P 500 for the 10-year period ended September 2016. The upshot: More than a third of these stocks underperformed the diversified 60/40 portfolio and all them showed much higher volatility – on average, more than three times that of the diversified portfolio.
This alone is a significant drawback. We haven’t had a bear market in years, but one is coming at some point – it always does – and it is a bear market, in particular, that challenges investor confidence. As the market keeps declining, investors tend to worry whether it will ever end. It is a particularly nerve-racking experience for retirees living on fixed incomes. Yes, the bear market will eventually end, but that simply means the market overall will rebound significantly – not necessarily your particular stock.
The bottom line is that there is no perfect way to know which stocks will be winners over the long term. And the cost of being wrong can be high.
If too much of your wealth is concentrated in a single stock, think hard about the wisdom of your strategy and weigh changing it. If you like a particular stock that much, you can still keep it. But make it a small slice of the pie, not the whole pie.
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