Evaluating Concentration Risk

I recently met with a client of mine to review their overall equity awards.   It had been a while since we looked at the overall asset allocation as we have been more focused on the equity awards.

Interestingly, because of the recent rise in the stock market and specifically this executive’s company stock, I was shocked when I discovered this executive had over 50% of their net worth in company stock and options. This concentration has increased the executive’s net worth substantially, but comes with added risk.

Weighing in on the risk:  As I discussed several years ago in a white paper titled “Understanding the Risks Associated with  Concentrated Stock” the additional risk the executive is taking on is uncompensated.  In other words, holding a large percentage of one stock will not necessarily increase the shareholder’s return, but subjects them too much greater risk.  Measured by volatility, a single concentrated position can have more risk than the most aggressive diversified portfolio.

Dan’s Moral:  By holding a concentrated position in company stock, the executive is not rewarded compensation for the additional risk.

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