By: Colleen Weber
Investment / News and Updates
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By Colleen Weber, CFP®, CPA
You’ve probably heard the phrase “Don’t put all your eggs in one basket.” The more I’ve helped people manage their finances, the more I’ve seen how true this is. Most advisors will tell you that diversification is the best way to structure your investments, but what about that company that seems to be the next big thing? We want to get on the hype train and start buying up stocks in that company, right? But here’s the quite literal million-dollar question: How much stock from one company is safe to own?
Now, there’s no easy answer to that question, but there’s no denying that when you concentrate your investments on an individual stock, the risk goes way up. Let me show you 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.
I have been helping people with this lesson for years and can help you 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
I understand; investing on your own can be a challenge (and even intimidating). Investing without a guide can lead to confusion and frustration. My goal is to help you find peace with your financial plan so you can work toward your dreams. When you work with me you can rest easy knowing you have a trusted partner guiding you on your path to financial success. If you’re ready to take that next step toward financial freedom, book a free introductory meeting online or call (952) 470-0750.
Colleen Weber is a fee-only financial advisor, CERTIFIED FINANCIAL PLANNER™ professional, and CPA with more than 15 years of financial planning experience. Providing comprehensive financial planning and wealth management, she specializes in serving clients nearing retirement, retirees, busy professionals, and women. She is passionate about developing financial plans that save clients on taxes and investment strategies that help them pursue their goals. Learn more about Colleen by connecting with her on LinkedIn or booking a complimentary phone call meeting.