Dealing with a concentrated portfolio

December 31, 2022
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Q: I retired ten years ago after a successful career working for a large public company. Over the course of my career, I accumulated a large amount of company stock. Every advisor I have talked to says I should diversify and rebalance my portfolio, but that would result in a huge tax bill. If I diversify, I don’t see how I would ever be able to make up the loss from taxes. What are your thoughts? I want to be safe, but I also want to be smart.

A: As you have experienced, you can make a lot of money by concentrating your portfolio in a few winning assets. Unfortunately, concentrating your portfolio is also one of the best ways to lose a lot of money. Just ask crypto currency mogul and FTX founder Sam Bankman-Fried, known by the initials SBF. In a recent article, Forbes magazine estimated that SBF’s net worth collapsed from $24 billion in March to $0 at the end of November, making him the 2022 champion of the world’s biggest loser contest. Of course, there were other shenanigans going on, but you get my point. A concentrated portfolio can lead to catastrophic losses.

If SBF would have enquired last March, I suppose an entire army of financial advisors would have suggested that he diversify a portion of his assets out of crypto currency and into a portfolio of well-diversified high-quality stocks. But I can almost hear him say, “That would be crazy. The cost basis on most of my holdings is close to zero. Can you imagine what my tax bill would be? There is no way a portfolio of stocks would ever be able to make up that hit.”

SBF would have been right on his last two points: 1) He would have paid hundreds of millions of dollars in taxes, and 2) there is no way a diversified portfolio of blue-chip stocks could ever have made up the difference. But that misses the point. We don’t diversify to create wealth; we diversify to protect wealth. Had SBF diversified a mere 8 percent of his net worth, he would still be a billionaire, even after paying the massive tax bill.

This story is not rare, nor is it limited to the rarefied world of crypto currencies. In fact, it has played out in companies as diverse as General Electric, Washington Mutual, Kodak, Tyco, Enron, and a whole host of Silicon Valley tech companies. In each case, employees in those companies accumulated larger and larger holdings in their company’s stock as their portfolios grew more and more concentrated. They resisted the call to diversify—often because they feared a big tax bill—only to lose a lot more than taxes would have ever cost them.

Which brings me to my point. You definitely want to be tax-smart when you make financial decisions, but taxes should not be the only consideration. There are some fates worse than a big tax bill.

As in the SBF example, you may not need to diversify your entire portfolio. The right amount of diversification for you depends on size of your portfolio and the kind of lifestyle you are trying to protect. The smaller your portfolio or the larger your lifestyle, the more you will need to diversify. A good financial planner can provide invaluable support as you work through this question. Properly diversifying your portfolio will bring you peace of mind.

One final point about diversification and taxes. Some people, especially as they advance in years, begin thinking about the benefit their heirs will receive when their low cost basis stock gets a step up in basis upon their death. This anticipated benefit tempts them to hold onto concentrated positions that they otherwise would diversify. Again, they are missing the point. Diversification of at least a portion of their portfolio also protects their heirs from a catastrophic collapse in the stock’s value. There my be a price to pay for that peace of mind. A good financial plan can help you decide if the price is worth it.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.