There's no such thing as a 'risk-free' investment. Even seemingly risk-free investments such as FDIC insured CDs, Money Market Accounts and U.S. Treasury Notes carry risks including long-term devaluation due to inflation and loss of purchasing power.
Once you move into stocks, clearly no stock is devoid of risks. Stocks by their very nature have a fairly wide range of volatility.
5% Rule: No single stock holding should represent more than five percent of a client's total portfolio.
I'm reminded of a case where a client held a highly concentrated position of a particular bank stock. Over the decades, this stock had performed well and created significant wealth for this client. At review time each year I would remind her of our 5% rule and recommend that we sell a minimum of ten percent of her holdings, noting that if the stock continued to rise she might simply be 'treading water' on the value but reducing risks over time by diversifying into other stock holdings. Because this was the stock that 'brought her to the party' and was a gift from her father, she continued to resist selling any shares. Then the Great Recession of 2008 hit...and hit bank stocks particularly hard. When this $25 per share stock had fallen to $1 per share I get the phone call, "Sell!", she screamed into the phone!
Of all the stocks I have watched over the years, this bank stock appeared to be one of a handful that I thought just might be the golden ticket...until it wasn't. What I learned was that there's absolutely no such thing as a 'sure thing'. There's the potential 'black swan event' for virtually any investment. This is why the 5% Rule is so important.
Exceptions to the 5% Rule
- Management.
- Senior Management.
- Taxes.
- For more elder clients we might 'wait it out'...
- Sell shares over a number of tax years.
- Gift low-basis shares to charity.
- Hold the over-concentrated shares.
What to do now
Review your portfolio to identify any stock positions exceeding five percent and make a conscious decision regarding appropriate changes, if any.
Stewart H. Welch, III, CFP®, AEP, is the founder of THE WELCH GROUP, LLC, which specialize in providing fee-only investment management and financial advice to families throughout the United States. He is the author or co-author of six books including THINK Like a Self-Made Millionaire; 100 Tips for Creating a Champagne Retirement on a Shoestring Budget; andJ.K. Lasser's New Rules for Estate, Retirement and Tax Planning (John Wiley & Sons, Inc.). Visit his Web Sitehttps://welchgroup.com/next-step/. Consult your financial advisor before acting on comments in this article.
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