By Michael Hathaway, CFP®, CFA®, AIF®
It’s common knowledge that a few companies seem to dominate the stock market year after year, catching the eyes and attention of many investors. We understand these companies can be hard to ignore! For this reason, many individuals are asking themselves: How much stock from one company is safe to own?
As with most financial questions, there is no cookie-cutter answer. However, we do know that concentrated investment in individual securities carries increased risk. Let’s see why.
The Risks of Investing in Any Single Stock
Individual stocks are much riskier investments than a well-diversified portfolio. Why is that?
Here are a few kinds of risk you are exposed to when you hold any single stock, or if your portfolio is heavily invested around one single stock:
- Management risk: A company may have a stellar history of management, but there are no guarantees that won’t change in the future. A change in management, like a CEO stepping down, can cause a significant shift in how the company performs, the future prospects for the company and, in turn, the current price of the stock.
- Industry-specific risk: When you are invested in a stock, you are also invested in that industry. If this industry takes a hit from world events, supply chain issues, changing consumer demand, or rising costs, your individual stock can also go down in price.
- Legal risk: If the company of the stock you hold gets into legal problems, it can lead to investor concerns, and the stock price could drop.
- Technological risk: Technology is continually changing and advancing. It is nearly impossible to predict these changes, and when major advancements in technology occur, it could render an entire company or industry obsolete.
Lastly, the more you concentrate your investment in a single company, you also run the risk of becoming emotionally invested in the company. When the company you’re invested in doesn’t do well, this can lead to sub-optimal investment decisions (e.g. selling at low prices).
When you have most of your money concentrated in any single stock, if something goes wrong, you stand to lose a significant portion of your investment. But this can be avoided.
The Importance of Diversification
Diversifying your portfolio gives you exposure to companies and industries that appeal to you without the danger of putting all of your eggs in one basket.
There are many factors outside your control, such as future company performance, industry changes, and world events.
Diversification means spreading your portfolio across different types of investments, and across many different companies in many different sectors, industries, and geographies. This reduces the risk that you will lose all your money to any single investment.
At Epsilon Financial Group, we understand how to build well-diversified portfolios suited to your individual circumstances.
The Bottom Line
With any investment, you need to consider your risk tolerance and goals before you make a purchase. All investments carry some amount of risk, but diversifying your portfolio can help you minimize the risks of owning concentrated positions in any specific asset, company, or industry.
So when it comes to how much stock from one company is safe to own, the answer depends on your needs, goals, and risk tolerance.
We Can Help
Investing on your own can be a challenge (and even intimidating). Investing without a plan is like going on a hike with no map nor even an idea of where you want to go. When you want to have confidence in your financial plan, it’s wise to partner with a fiduciary financial professional. When you work with us at Epsilon Financial Group, you can rest easy knowing you have a trusted partner guiding you on your path to financial success.
To create a comprehensive financial plan, we take a holistic view of all your financial specifics, think creatively to help you identify and attain your financial goals, and continually monitor your plan to ensure you stay on track. We are firm believers in transparency and clear communication, and we will walk with you through every step of the journey. Email me at Mike@wealthmatters.com or call (707) 428-5500 to get started.
Michael Hathaway is a fiduciary financial advisor at Epsilon Financial Group, Inc., an independent, fee-only wealth management firm. Mike has worked in the finance industry for more than 20 years and brings a wealth of knowledge and experience in sophisticated financial planning to help his clients make sound financial decisions. He is known for caring deeply for his clients’ well-being, being compassionate, and thinking creatively to help clients attain their financial goals. He prioritizes building long-term relationships and takes the time to listen, understand, and explain so that his clients feel confident in their financial plan. Mike is a CERTIFIED FINANCIAL PLANNERTM, Chartered Financial Analyst® (CFA®), and Accredited Investment Fiduciary® (AIF®) professional; he has a bachelor’s degree in cybernetics from UCLA and an MBA in finance and accounting from the University of Virginia. When he’s not working at Epsilon, you can find Mike enjoying anything related to exercise and fitness. He especially loves activities in the great outdoors, such as mountain biking, camping, hiking, and snowshoeing. In the fall of 2016, Mike successfully climbed to the top of Mount Whitney in a single day, the highest peak in the continental United States. To learn more about Mike, connect with him on LinkedIn.