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It’s always great to have an investment that is a shinning star, but it’s possible for that star to explode.  Investors sometimes find themselves with a concentrated stock in their portfolio, and may not understand the implications of holding such a position.  In general a concentrated position is one that represents more than 10 percent of your portfolio.
 
There are several ways that an investor can accumulate a concentrated position.  Employees of companies are prone to accumulate concentrated positions because of things like equity compensation, stock plan purchase arrangements, and buying
additional shares based on the belief in the company over the long run.  Two other scenarios leading to concentrated positions are inheritances and price appreciations.
 
The reason why this is an issue is because the stock market can be a fickle thing, and anytime you invest you expose yourself to various types of risks like: market risk, liquidity risk, reinvestment risk, exchange rate risk, and business risk.  Having a concentrated position gives an investor less flexibility in managing the risk for that security.  The success of the individual position will be based largely on how the company associated with it does, and history is full of examples of this going bad at the investors expense.
 
A prominent example of investors losing big due to concentrated positions is Enron.  Investors lost hundreds of thousands of dollars, and in some cases millions as the sentiment toward Enron, and also the company stock value declined.  A more recent example is that of Lumber Liquidators, whose stock price began to decline after
the 60 Minutes story said that their laminate flooring made in China, had high levels of Formaldehyde, which is known to cause cancer.  So far the stock price of Lumber Liquidators has declined over 40% this month from where it closed at the end of February around $52 per share.  
 
Reasons People Delay Selling a Concentrated Position
 
Tax implications- due to capital gains.
Future price considerations- thinking the stock will continue to rise or rebound if on the decline.
Emotions- some investors have ties to companies that make them want to hold on to a particular stock.

 
 
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I recently read an interesting article that implied millennials were afraid of investing.  The article further stated that 51% of millennials had not held a conversation related to handling their finances with even one person.  With the assortment of resources available to educate an individual about investing it’s shocking that over half of the millennial generation may not be taking advantage of these conversations.  Most brokers offer free planning conversations.  Also banks and credit unions would love to talk to their customers about planning, and increasing their long term assets.  Furthermore, just about everyone knows someone who has experience with investing that they could talk to.

The article then detailed another shocking statistic from a 2014 Bankrate.com study stating that 39% of respondents aged 18 to 29 say cash is their preferred way to invest money that they don’t need for at least 10 years.   Being one of the major asset categories cash definitely does play a part in one’s portfolio. Cash is great if money is needed in the short run; say within the next two years because you do not have to worry about fluctuations.  However, given a 10 year timeframe that money would be better off being invested in other assets besides cash because of inflation risk. 

More on Inflation Risk

Inflation is an increase in the cost of goods or services, so a dollar today will not buy the same amount of stuff at some point in the future.  The lack of ability to buy the same goods with said dollar is also called a reduction of purchasing power.  Economies need a certain amount of inflation in order to grow, so if your cash earns less than the inflationary amount you are in trouble.  Currently rates for CDs and Money Market accounts are less than 2%, unless you are locking your money in for longer periods of time.  The great thing about investing in stocks is that for the risk you take on you receive a rate that is typically higher than inflation which allows your money to grow over the long run. 

Emily Pachuta, head of Investor Insights for UBS Wealth Management, said in a release. "Millennials seem to be permanently scarred by the 2008 financial crisis," and that “they have a Depression-era mindset largely because they experienced market volatility and job security issues very early in their careers, or watched their parents experience them, and it has had a significant impact on their attitudes and behaviors."  That change in attitude has led to an increased preference for cash with an average of 52 percent of millennials portfolios being in cash, compared to 23 percent for investors of other generations.  Investors who are risk averse think that it’s a smarter bet to be in cash, not realizing that they have already lost money due to the inflation risk which cannot be avoided.  In the long term, inflation erodes a portfolio’s purchasing power significantly.  At an average inflation rate of 3% per year, the value of a portfolio is cut in half every 23 years or so. 

The Cost of Being Out of the Market


Below is a graph that shows just how much money an investor could lose by being out of the market on the best days over a given timeframe.


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Being Realistic

When it comes to investing one of the best things you can be is realistic.  An investor needs to be realistic about their experience, goals, and  expectations.   Firstly if you do not have adequate investment experience there is help to be obtained.  Many books, videos, and seminars are made readily available to assist.  Most, if not all brokerage firms offer some form of investor education.  It will continue to pay dividends, no pun intended to invest in your individual knowledge about investing and investing products.  The reason that goals and expectations were listed separately is because they take on different levels of importance for each investor, and must be considered separately.  Investing goals can include things such as: saving for education, retirement, or investing extra savings.  An investment expectation is what you expect the results of the investing to be.  For instance, you save/invest $200 per month for 2 years ($4,800), with the expectation that at the end of two years it will grow to at least $5,500.  The expectation that the funds invested over two years could reach $5,500 is realistic.  What is not realistic is for an investor to decide to invest $10,000 with the expectation that it will grow to $100,000 in one month’s time.

Taking On Risk

Investing is sort of like running track, in the sense that the person who puts in the most can expect above average returns.  Three things that help to increase returns for investments are time, amount, and risk.  Over longer period of times investments have more room to grow and rebound from any fluctuations in the market.  Amount is important because when you invest more you increase the chances of getting returns.  More invested does not mean all though, you should never invest more at a given time then you could comfortably afford to lose.  Risk is one of the greatest considerations when factoring in returns, because the more risk you take on the greater the potential returns that exist.   Stocks have historically had the greatest risk and highest returns among the three major asset categories.*  Included in the three major asset categories are stocks, bonds, and cash.  People who invest in stock would naturally expect a higher return due to the fact that they have taken on more risk.  Whereas someone who has invested in cash would be willing to accept a lower return for the knowledge that their funds typically do not experience extreme fluctuations in value like stock or bond investments.

Appropriate Asset Allocation

Asset allocation involves finding the right mix of stocks, bonds, and cash equivalents for your portfolio.  As stated earlier in the Taking On Risk section, time and risk will play big parts in determining the right mix.  Typically younger investors who are further away from retirement or people without an immediate need for the funds will tend to have allocations with robust stock components.  Older investors, people close to retirement, and those with a near term need for funds will tend to have large bond and cash components in their asset allocation.  On the low end of the asset allocation spectrum are your conservative investors, and on the other end are the more aggressively inclined investors.  Each asset allocation profile has its on return profile over a period of time; say a year or five year time frame.  Below will be a sample suggested allocation breakdown that highlights returns over a 10 year time period (for illustrative purposes only, average returns could be different now, and appropriate mix is based on many variables).  Suggested Allocation Breakdowns *1
  Suggested Allocation Breakdowns *1
Suggested Allocation Breakdowns *1

Aggressive



   20% Large-Cap Stocks

   20% Mid-Cap Stocks

   20% Small-Cap Stocks

   20% International Stocks

   10% Emerging Markets Stocks

   10% Intermediate Bonds

   0% Short-Term Bonds

Moderate



   20% Large-Cap Stocks

   20% Mid-Cap Stocks

   10% Small-Cap Stocks

   15% International Stocks

   5% Emerging Markets Stocks

   30% Intermediate Bonds

   0% Short-Term Bonds

Conservative



   25% Large-Cap Stocks

   10% Mid-Cap Stocks

   10% Small-Cap Stocks

   5% International Stocks

   0% Emerging Markets Stocks

   40% Intermediate Bonds

   10% Short-Term Bonds

Aggressive Portfolio Return

YTD:

2.7%

1 yr:

9.6%

5 yrs:

11.6%

10 yrs:

8.2%

Moderate Portfolio Return

YTD:

3.0%

1 yr:

8.5%

5 yrs:

10.1%

10 yrs:

7.4%

Conservative Portfolio Return

YTD:

3.4%

1 yr:

7.8%

5 yrs:

8.9%

10 yrs:

6.4%

 

* http://www.sec.gov/investor/pubs/assetallocation.htm

*1 http://www.aaii.com/asset-allocation