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Tips for Dealing With Concentration Risk, Ep 46

In today's episode, I'll go into a bit more detail on one of the more popular podcasts I have recorded to date. The topic is concentration risk. I've already covered what concentrated risk is in a previous episode so we will talk about some specific strategies to reduce your risk. 

Concentration risk tends to happen slowly over time. It’s the amount of risk you take by investing in one—or a couple of similar positions. I'm not going to go into a more complex definition of concentration risk as honestly, I don't think anyone cares. Instead, I'm going to ask you my favorite concentrated risk-related question. If you were not a current employee of this company, how much of their stock would you own in your own portfolio?

You will want to hear this episode if you are interested in...

  • What is concentration risk? [0:46]
  • How much of their stock would you own if you didn’t work there? [1:16]
  • Looking at the forest [4:14]
  • Looking at the trees [5:55]
  • The percentage of holdings in your one concentrated position [8:44]
  • Rebalancing [9:39]
  • This week’s FLASHBACK [11:51] 

How do you end up with concentrated risk?

Concentration risk grows over time. You start by buying a few shares through your employee stock purchase plan. Then you're awarded some restricted stock units or maybe some restricted stock itself, and later you pick up some non-qualified stock options. You've been receiving these positions for 20 years without regularly giving it the attention that it deserves and now half or more of your net worth is tied up into one stock. Keep reading—or better yet go listen to the episode—for tips on how to reduce your risk.

Tips for reducing concentration risk

The first tip is to look at the forest. In this case your entire net worth and where you're invested. We're trying to see how well you are diversified. Then the second logical step, and maybe a subpart of the first tip is to look at the specific holdings you own. Now we're looking at the trees in the forest. The third tip is to determine what percentage of your overall holdings you want to hold in your one concentrated position. Are you comfortable with having 70% of your net worth in one company stock or is 30% the highest you want to be? I would recommend getting with your CFP to determine which level is right for you. Now that you've identified that percentage, it will help guide your overall investment approach.

Your final tip is to rebalance. This is just identifying how much you wish to hold in what positions. This is where the previous tip about identifying how much you will hold in your company stock comes into play. Now that you figured out that number, you can start determining the other appropriate percentages.

This week’s FLASHBACK: It’s a small world, be careful who you flip off

There's a joke in Akron to never flip off somebody in traffic because odds are, you'll be sitting in a meeting with them later in the day. I'm sure this is true for many communities, maybe a little more so in Akron, since we're not a growing community, and most people who live here have lived here for years. Regardless, it's a small world and on a few occasions, the smallness has extended beyond the Akron borders. 

Twice in one day, I ran into former classmates when the Cleveland Indians went to Chicago to play the Cubs for the first time. We're at the game heading to our seats. The place was packed. I heard someone call Dan, then heard the same voice yell my full name. I took a look and it was an old high school classmate. Then after the game, we headed to a local bar and the scene played over again. This time was from some friends who I hadn't seen in a few months. I'm sure you have similar stories of what I call the small world effect. I guess it goes to show you can't hide anywhere. And also to be careful who you flip off, regardless of where you live.

Resources & People Mentioned

As always, thanks for taking the time to read this. Please do not hesitate to reach out if I can be of help with your equity compensation-related questions. The easiest thing to do is to click the little green box that reads “Schedule a Meeting” that can be found at the bottom of every page on my website. Or, just click my Calendly link right here.

 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.