Time to check your balance?
12th June, 2018
While everyone appreciates the need for balance in today’s fast-paced world, it’s startling how few apply that same principle to managing their financial lives. Senior executives, who receive company stock as well as salary and pension contributions from the same company, are perhaps the most susceptible to tripping up.
In career terms, company stock is a tangible measure of achievement – it’s there because you’re doing well; you are valued. So, your hard work has paid off. Now what? After all, it’s not how much you have, but what you can do with it that counts.
To wait may be too late
Whether you’re lured by the possibility of a big win or you simply assume the future will be like the past, I can tell you from experience that most investors are not being compensated for the risks they are taking by holding onto large single-stock positions.
No matter how well-managed a company is or how it has performed in the past, no company is immune to the risk that the future could look very different. And let’s not forget that we actually pay for things with cash, not stock. So if there’s a sharp decline in the stock and the need for cash arises before that stock recovers, you may be forced to sell at an unattractive price (or even a loss). These days, a wait-and-see strategy carries more risk than you might be able to afford. Most of the time, when you really think about it, the risk of not being able to meet certain financial obligations or intentions outweighs any potential opportunity cost. “A bird in the hand is worth two in the bush” comes to mind here.
The logic of diversifying
The bottom line is that when an investor holds a concentrated stock position, the impact of any volatility is magnified. Whereas, when you hold a more diversified mix of investments—a variety of stocks, bonds, cash, etc.—the ups and downs are mitigated by the fact that when one goes down, the other may go up and vice versa.
Regardless of how your stock was acquired – executive compensation, a company merger, inheritance – a concentrated position invariably results in a disproportionate allocation of wealth, and that is risky business. Add to that the fact that same company pays your income and your pension and you’re all the more exposed. Eggs, basket, you know the rest.
Diversification helps you balance risk and reward, reducing the impact of a stock’s volatility on your cash needs. Understanding and effectively managing these risks can be the difference between achieving your goals--and not. This is where planning and financial advice comes in.
Talking to a financial adviser will help you understand exactly what is at risk by holding on to a concentrated stock position—in your own terms. For example, how would a pullback in the stock price affect your current standard of living or your future plans? Would you be less relaxed in your day-to-day spending if your ‘paper wealth’ took a nose dive? Would you still be able to retire how and when you wanted? And how would your partner feel about all this uncertainty. While everyone’s financial circumstances are unique, by and large we are all working toward the same goal – to provide for ourselves and our family and create enough opportunity to enjoy life.
While stock concentration may create wealth, diversification can preserve wealth. A well-balanced approach to managing your money, one that is consistent with your true risk appetite and in-line with what you ultimately want to achieve with your money will give you the best possible chance of success.
Warning: The information in this article does not purport to be financial advice and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. You should seek advice in the context of your own personal circumstances prior to making any financial or investment decision from your own independent adviser.
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