We've seen the market give up quite a bit of gains this year. Maybe after the last decade plus of great years we’ve forgotten that the market can go down. Who knows if we will end the year negative, but right now, things are looking good for those accumulating assets. Not so much for those in retirement or nearing retirement. Regardless, I want to spend a few minutes talking about something I deal with a lot...concentration risk. The emphasis in this episode will be ways to reduce your concentration risk for times like these with down markets and extreme volatility.
You will want to hear this episode if you are interested in...
Defining what concentration risk is
Starting at the beginning we need to define what concentration risk is exactly. The simplest definition is that it is the amount of risk you are taking by investing in one stock. This is common in the world of equity compensation. You started out by participating in your employee stock purchase plan through payroll deduction. Maybe you're also awarded some restricted stock, restricted stock units, and or non-qualified stock options.
This all starts off harmlessly and positively. However, over time the amount of company stock that you are accumulating becomes a larger and larger part of your overall net worth. What I see happen time and time again is your concentration risk gets larger and larger because not only do you acquire more shares, but the value of the shares also starts increasing, at least hopefully it does. But stocks don’t always go up.
As you get closer to retirement you probably do not want to take as much risk with your net worth. And it could drop substantially due to a drop in the value of your concentrated stock position. In those cases, it may make sense to start reducing your concentration risk to a more tolerable level. So let's get into some of the tips.
Tips for reducing your concentration risk
Your first tip involves stop losses. Specifically, stop limit orders. These are orders you put in to sell or even buy a stock once a certain price is hit. There are two parts to the strategy and I cover them, and more details on each tip listed below, in the episode so go check it out.
Another tip is to look at charitable giving. Odds are you just write a check out of your bank account which makes total sense. However, what if you were able to donate some of your company stock. You would achieve many goals and potentially reduce your tax burden too.
My next tip gets a little more complex to execute. It has to deal with bracketology, but not the basketball kind. I'm just talking about filling up tax brackets.
Now here's probably the simplest tip to reduce your concentrated risk position, stop participating in your company's ESPP. I know it hurts.
The last tip I want to share is to be aware of the big picture. Maybe I should say, to be considerate of the forest for the trees. I simply mean to know not only your concentrated stock position but also your overall portfolio.
This week’s FLASHBACK: Hiking Trails - Furnace Run
Let's talk about another hike in the greater Akron area. This is not my favorite spot, but it's a popular one so I do wanna share it. It’s Furnace Run it's a small park in the Northwest portion of Summit County. I guess it's not that small because there's a shelter, a small pond for some fishing, some open fields, and a few trails to walk. Honestly, the only reason I ever go is that it shows up in the fall hiking spree list. Part of the reason I don't like it is that it's so popular, lots and lots of people like it but I prefer to hike and kind of be alone or at least not with a million other people. The trails themselves are relatively easy and it's not too far off some main roads. The parking's right there and it's not too far off the beaten path. Again, not a terrible spot, but not on the top of my list. I promise next time I'll share a trail that I really do like.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.