Every investor worries about picking a stock that goes wrong.
But what if things go right – like, very right?
It’s a great problem to have – but that situation presents some unique challenges all on its own. Just ask Clark Randall.
The Dallas financial planner saw the writing on the wall this past spring, when COVID-19 was starting to transform America and coop us all up in our homes. He figured that technology would be the big beneficiary of this societal shift.
So with some personal savings in his IRA he put together a “Pandemic Portfolio,” of well-known tech stocks like Google, Microsoft, Apple, PayPal and DocuSign.
Boy, was he right. This year tech stocks have powered along nicely, even in the midst of a broader recession, a GDP collapse, and millions of job losses.
But when this 20% portion of Randall’s portfolio started rocketing towards 30%, he needed to figure out next steps. His net worth had become extremely concentrated in tech – and left him vulnerable if the sector ever ran into trouble.
Keeping your head
It’s an issue that many investors are facing in this curious year of 2020. While some areas of the stock market have suffered greatly – financials, energy, small caps – others, like Big Tech, have soared to new highs.
That means the asset allocation in your portfolio could be highly out of whack. As an example, the popular exchange-traded fund QQQ, which tracks the tech-focused Nasdaq 100, has spiked 46% in a year.
“My portfolio became very tech-heavy,” says Randall, who decided to trim back those holdings this summer when they kept galloping to new highs. “When things start getting too big, too fast, that’s when you have to think about selling and putting it into other things that haven’t grown as much. That’s smart rebalancing.”
In some cases, this lopsidedness can become extreme. Pittsburgh financial advisor Diane Pearson handles money for an elderly couple who had the foresight to buy Apple stock decades ago — at an average cost basis of $2.40 a share.
Since it now stands at over $450, that means they are sitting on a single position of $1.5 million — amounting to roughly 60% of their net worth.
“It’s a nice problem to have, but that kind of concentration is also a big concern,” says Pearson — who has another client in a similar position, having bought drugmaker Merck back in the ‘50s at a cost basis of 8.5 cents a share.
Of course most retail investors shouldn’t really be speculating in individual stocks anyways, and instead stick to broader funds to spread out their risk. But if you do find your portfolio tilting heavily towards tech these days, a few thoughts to consider:
Start with trimming
If valuations of your big winners get lofty, don’t imagine you have to make extreme movements and sell everything right away. Instead, think like a cautious gardener and do a little pruning: If your 20% position has ballooned to 30%, maybe trim back 5 or 10 percentage points, and devote those proceeds to areas of the market that you think are undervalued. That way you can still enjoy the ride of your smart stockpicking, but reduce your risk at the same time.
“Whatever your right allocation was going in, you should always come back to that original allocation,” says Randall. “If your holdings are more than 5 percentage points out of balance, think about selling that extra 5% and investing it somewhere else -- that way you are automatically always selling high and buying low.”
Factor in taxes
If your growing tech holdings are within a retirement account like an IRA, then it’s not going to create any taxable events if you trim or sell out. But if they are in non-retirement taxable accounts, selling winners will mean a year-end tax bill. So consider the nature of your accounts first, before you make any decisions on how to handle your tech windfall.
In the case of Pearson’s elderly Apple millionaires, the shares are in taxable accounts — and that creates an additional psychological barrier, of not wanting to get walloped by Uncle Sam. “It may hurt in the short-term, because there could be a lot of taxes to pay and result in a reduction of your net worth,” she says. “But in the long run, it will be a more comfortable position not to carry as much risk.”
One way to avoid a big tax hit is to consider gifting some of your tech stocks. If you give them to a child, for instance, you avoid triggering a tax event — current annual gifting limits are $15,000 a year, per person.
Or you could make them a part of your larger charitable plan. Diane Pearson’s clients, for instance, are mulling over putting some of their Apple shares into a donor-advised fund — which would give them an immediate tax writeoff, and then let them donate over time to charities of their choosing.
Go back to your long-term plan
If you have put together a financial plan, you should already have general guidelines about asset allocation at different stages of life. Unless things have changed drastically for some reason, the plan is still there and those allocation targets are still in effect. So go back to the playbook that you have already written up.
Of course, there is no blanket allocation prescription for every investor. But as an example, Baltimore-based fund managers T. Rowe Price offer these age-based allocation models: Those in their 40s should be between 80% to 100% in stocks, and 0% to 20% in bonds; those in their 50s should be 65% to 85% in stocks, and 15% to 35% in bonds; and those in their 60s should have shifted to 45% to 65% in stocks, 30% to 50% in bonds, and 0% to 10% in money markets.
Be aware of your behavioral biases.
It’s entirely natural to want to hold onto your Golden Ticket. When we pick a great stock it gives us a warm fuzzy feeling, as we look at our gains and consider our own genius. Why would we ever want to give that up?
Throw in the FOMO phenomenon – Fear of Missing Out – and it can be a powerful disincentive to selling. “We fear missing out on a meteoric rise,” says Sarah Newcomb, a behavioral economist at research firm Morningstar. “Where we once would have been satisfied with a hefty return on our investment, we now feel that anything short of maximum possible earnings is a failure.”
If you are aware of these behavioral biases, though, you can take action to mitigate them. Her suggestion: Anchor yourself with a price target. “Set a price threshold that represents a return you are truly thrilled with,” Newcomb says. “If the price exceeds that amount, and nothing has changed to the fundamentals of the company, then sell at least some of your shares. Sell enough to reap a profit from your initial investment -- and then you’re playing with house money.”