How much of one stock should you hold?
Srikanth Narayan
Founder and CEO
Editor’s Note: EquityFTW consulted on the creation of this article. We highly recommend their blog as a resource for managing the risks associated with highly appreciated stocks.
If you earn stock-based compensation – or if you’ve seen a few well-timed investments pay off – it’s quite natural to become overly concentrated in one or two stocks.
It can be very hard to decide when to continue holding a well-performing stock and when to diversify. While it’s certainly a good problem to have, it’s a problem worth paying close attention to.
To help you think through your portfolio choices, we’re going to take a quick look at how much the market has grown the last few years, as well as how quickly things can change. Then, we’ll offer a checklist to help you turn your financial gut check into a more deliberate decision about when to start diversifying.
Let’s start with the positive:
Times have been good
As of August 2024, the Nasdaq-100 has grown by over 1500% in the past 15 years. It’s been one of the greatest bull runs in stock market history.
That means many individual stocks have been doing well, but some companies have grown explosively – and not just the Mag Seven tech stocks. For example:
- Arista Networks is up over 18X
- AMD is up over 35X
- The Trade Desk is up almost 30X
- Even companies like Eli Lilly, Costco, and United Healthcare are all up over 15X
These examples are for illustrative purposes only and are not recommendations to buy any security. Returns for Arista Networks and The Trade Desk are calculated from their inception dates, as they were not publicly traded in 2009.
Disruptive technologies and business models have driven most of this growth. Mobile and cloud computing have dramatically increased the reach of technology, for example. The recent rise of AI (and the chips to deliver it) and the development of more innovative business models around software delivery have also had outsized impacts.
Whatever caused the growth of a particular company, the result has probably been good for you if you’re reading this article. While your net worth has grown on the back of one or two stocks, it also means your risk has grown.
Market risks versus business risks
In our complex global economy, we never know where the markets will be a month from now. Just in the past five years, we saw Covid-19 ravage the markets over the course of a few weeks. We also saw inflation drive interest rates higher, leading to a banking crisis in 2023. And in the past few months, attempts to unravel a Japanese currency gambit caused a worldwide market correction.
While the risk of loss exists with any diversified investment, it’s significantly higher when concentrated in a single stock. For instance, the 2023 banking crisis, which caused only a modest drop in market indices, proved devastating for individual stocks like Silicon Valley Bank, Signature Bank, and First Republic.
Business risks can also manifest gradually when companies fall behind the competition and slowly lose market share. Yahoo, for example, lost 80% of its value over the period of several years in the 2000s. Even with highly innovative products, Dropbox and Box have struggled to rise above initial IPO prices over the last decade.
Deciding when and how to sell is ultimately a subjective decision, but moving your portfolio from dependence on a single stock to a more diversified allocation objectively reduces your risk. And given how well the markets have done, a diversified portfolio would have outperformed most individual stocks over the past 20+ years:
So, how much of one stock is too much?
The conventional wisdom is that you’re exposed to concentration risk when you hold more than 10% of your portfolio in a single stock. As a concentrated position grows beyond 10% of your portfolio, the risk you’re exposed to increases quickly.
Here’s the informal scale we use internally to describe levels of concentrated positions:
- 10% to 25%: Pushing your luck
- 25 to 50%: Tempting fate
- 50 to 75%: Paying with fire
- 75% to 100%: Going #YOLO
To calculate your concentration risk, just divide the value of your stocks in a company by the value of your overall investment portfolio.
It sounds simple, but there can be a few wrinkles to consider. First, make sure to include all your retirement accounts.
Also, keep in mind that there can be hidden concentration in some of the ETFs or other investments you hold. At the time of writing, for example, Apple, Nvidia, and Microsoft each make up more than 8% of the Nasdaq-100 index (NDX). If your portfolio was 97% NDX and 3% Apple, it would look diversified, but it would be on the verge of overconcentration.
If you want to dive deeper into these calculations, EquityFTW has a nice overview.
When to the buck conventional wisdom
When you hold a position that continues to outperform, it might not feel like you’re holding too much stock. In fact, you may wish that you had more!
Whether you have too much of one stock is ultimately a subjective decision, but there are a few guardrails you ought to consider. For example, you should probably make sure you’re taking care of basic needs before gambling on a concentrated position.
Here are a few questions to ask yourself:
- Are you in debt? Do you have obligations that could drag down your future growth? Could debt become overwhelming if your concentrated position doesn’t pay off? The higher the interest rates you’re paying, the more important it is to pay off debts before taking on additional risk.
- Do you have major expenses in the near future? From a down payment on a house to paying for kids’ college, you may want to take enough off the table to make sure you won’t have to miss out on any major milestones.
- Do you work at the company? If you’re concentrated in the company that’s also responsible for your salary, there are two reasons to think about limiting your exposure: First, you’ll probably be earning more of this stock as your RSUs vest; and second, the potential loss of income exposes you to a second type of risk.
- Do you have taxes to cover? Capital gains taxes can run up quickly when you liquidate highly appreciated stocks. Additionally, you might have a looming tax bill when RSUs vest, or if you go through an IPO. You’ll likely want to make sure these expenses are covered before going long on a stock. We have a detailed guide for managing RSUs, if it helps.
Once you work through these practical considerations, it’s time to move into the truly subjective factors:
These six questions can help you check your prejudices and move beyond a mere gut check, but it’s helpful to take the exercise a step further.
How does risk feel when it’s more concrete?
In the past few years, we’ve seen several instances where a tech stock takes a big drop in a single day. It’s happened a few different ways:
A bolt from the blue event
Sometimes news comes out that quickly changes the market’s expectations (and hurts a stock’s prices). Here are a few recent examples:
- Snowflake’s CEO resigned unexpectedly in February 2024. The stock dropped by a third within two weeks.
- Snap announced disappointing earnings, also in February 2024. Its stock slipped 35% that day.
- Netflix missed subscriber numbers in April 2022, losing 35% in one day and 72% over six months. If you’d held NFLX for the prior 10 years, you would have been up over 30X prior to the dip – could you stomach losing so much, so fast?
Disruptive market forces
We talked earlier about how new technologies can drive growth. They can also hurt existing companies who start to see more competition:
- Google dropped 40% following the release of Chat GPT
- Grubhub lost 85% of its value as Uber Eats and Doordash emerged as viable competitors
- Intel has fallen by 60% this year as it retools itself to keep up with other chipmakers
Additional economic winds
Other forces, like shifts in consumer preference, macroeconomic conditions, climate change, or government regulations can lead to quick declines, too:
- Like we mentioned earlier, interest rate sensitivity destroyed the value of three high-performing banks
- And climate change is currently having an impact on companies like insurers and utilities. For example, PG&E lost 90% of its value and filed for bankruptcy under the weight of liabilities for the 2018 Camp Fire.
Could this happen to your stock?
We hate to focus on the negative, but that’s what mitigating risk is about. In many of these examples, companies have been and continue to be successful. Even the Magnificent 7 tech stocks that have driven much of the market’s growth recently have all seen a drawdown of 30% or more in the past five years. Meta, Tesla, and Nvidia all experienced 60% drops during that window!
So here’s the big question: How would you feel if your stock dropped 20, 40, or 60%?
Don’t ask yourself in the abstract. Do the math:
- How much money would you lose if that happened?
- How would losing that much money affect your financial outlook?
- How many more years would you have to work to make up for that loss?
- Would you still feel comfortable with your current level of spending?
While money can’t buy happiness, there are a lot of things you’ll need it for..
On the other side of the coin, it’s also worth asking whether taking on additional risk is worth the potential for future growth? How would the extra money change your life? If you beat the odds and your net worth doubled or tripled, what would that mean for you?
One final consideration
By now, you’re probably leaning one way or another. A factor that may tip the scales for you is how close you are to retirement. When you’re younger, taking more risk is generally more acceptable because you have more time to recoup any losses.
When you’re older – or close to giving up regular employment – it can be harder to recover from a loss. One major drawdown in a concentrated position can change your outlook significantly, and it can undo years of hard work, savings, and good fortune.
Keep in mind that diversifying doesn’t mean giving up on growth. When you have too much of one stock, spreading out your risk also means gaining new opportunities for growth.
Vanguard’s Jack Bogle, the father of modern index investing, had an interesting perspective on diversification. “Don't look for the needle in the haystack. Just buy the haystack!” Because they hold the best-performing stocks, index-based funds generally outperform most of the individual stocks they hold.
Look for tax-advantaged strategies
If you decide it’s time to diversify, there may be better ways to do it selling your stocks outright.
Selling stocks triggers capital gains taxes, which means it can gobble up a third or more of your principal if your stocks are highly appreciated. Before you log in and hit “sell,” make sure to understand your other options.
I started this company because I thought exchange funds – which allow you to diversify immediately while deferring capital gains – were inaccessible and poorly understood.
Let’s say you held $1M of Apple stock, with a cost basis of $100K. Here’s how an exchange fund would compare to diversifying and selling if you received a similar rate of return:
Try your own scenario with our exchange fund calculator, or take a closer look at The Cache Exchange Fund.
Other vehicles like direct indexing or donor-advised charitable funds can also offer some advantages over selling to diversify. We’ve also put together detailed looks at other tools for managing concentration risk.
In the meantime, I hope your stocks continue to perform well – and that you keep making timely decisions about your investments. Let us know if there’s anything we can do to help.
<div class="blog_disclosures-text text-weight-semibold">Material presented in this article is gathered from sources that we believe to be reliable. We do not guarantee the accuracy of the information it contains. This article may not be a complete discussion of all material facts and risks. and is not intended as the primary basis for your investment decisions. All content is for general informational purposes only and does not take into account your individual circumstances, financial situation, or your specific needs, nor does it present a personalized recommendation to you. It is not intended to provide legal, accounting, tax or investment advice. Cache does not make investment recommendations; investors are responsible for their own investment decisions. Diversification seeks to reduce risk by spreading risk across multiple investments however, Investing involves risk, including the loss of principal. Nasdaq-100 (NDX) is a stock market index made up of equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange. Investments cannot be made directly into an index.</div>
<div class="blog_disclosures-text">Securities are offered through Cache Securities LLC, FINRA/SIPC. Investment advisory services are offered through Cache Advisors LLC, an SEC-registered investment advisor. Cache Advisors and Cache Securities are wholly-owned subsidiaries of Cache Financials Inc “Cache” Cache and EquityFTW are unaffiliated entities. More details about how Exchange Funds work, including the risks and benefits associated with them, is available at: https://usecache.com/product/exchange-funds</div>
{{black-diversify}}
The Cache Exchange Fund can help.
Make better decisions for managing your large stock positions.
Sign up to receive all our insights and data.
